QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended July 1, 2007

OR

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission
file number 000-51593

SunPower
Corporation

(Exact name of registrant as specified in its
charter)

Delaware

94-3008969

(State or other
jurisdiction of

(I.R.S. Employer

incorporation or
organization)

Identification
No.)

3939
North First Street, San Jose, California 95134

(Address of
principal executive offices and zip code)

(408)
240-5500

(Registrants
telephone number, including area code)

Indicate by check mark whether the registrant
(1) has filed all reports required to be filed by Section 13 or 15(d)
of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90
days. Yes x No o

Indicate by check mark whether the registrant is a
large accelerated filer, an accelerated filer, or a non-accelerated filer. See
definition of accelerated filer and large accelerated filer in Rule 12b-2 of
the Exchange Act. (Check one):

Large accelerated
filer o Accelerated
filer x Non-accelerated
filer o

Indicate by check mark whether the registrant is a
shell company (as defined in Rule 12b-2 of the Exchange
Act). Yes o No x

The total number of
outstanding shares of the registrants class A common stock as of August 3,
2007 was 38,782,013.

The total number of
outstanding shares of the registrants class B common stock as of August 3,
2007 was 44,533,287.

The accompanying notes are
an integral part of these condensed consolidated financial statements.

3

SunPower
Corporation

Condensed Consolidated Statements of Operations

(in thousands, except per share data)

(unaudited)

Three Months Ended

Six Months Ended

July 1, 2007

July 2, 2006

July 1, 2007

July 2, 2006

Revenue:

Systems

$

104,037

$



$

182,532

$



Components

69,729

54,695

133,581

96,653

173,766

54,695

316,113

96,653

Costs and
expenses:

Cost of systems revenue

91,518



153,984



Cost of components revenue

52,456

43,248

99,912

79,514

Research and development

2,821

2,588

5,757

4,584

Purchased in-process research and development





9,575



Sales, general and administrative

26,109

4,985

48,480

9,366

Impairment of acquisition-related intangibles

14,068



14,068



Total costs and expenses

186,972

50,821

331,776

93,464

Operating income
(loss)

(13,206

)

3,874

(15,663

)

3,189

Interest income

2,196

2,078

4,180

3,252

Interest expense

(1,085

)

(509

)

(2,204

)

(849

)

Other income
(expense), net

(517

)

353

(243

)

490

Income (loss)
before income taxes

(12,612

)

5,796

(13,930

)

6,082

Income tax provision (benefit)

(7,267

)

412

(9,825

)

443

Net income (loss)

$

(5,345

)

$

5,384

$

(4,105

)

$

5,639

Net income
(loss) per share:

Basic

$

(0.07

)

$

0.08

$

(0.06

)

$

0.09

Diluted

$

(0.07

)

$

0.08

$

(0.06

)

$

0.08

Weighted-average
shares:

Basic

75,123

64,040

74,428

62,583

Diluted

75,123

69,408

74,428

68,172

The accompanying notes are
an integral part of these condensed consolidated financial statements.

4

SunPower
Corporation

Condensed
Consolidated Statements of Cash Flows

(in thousands)

(unaudited)

Six Months Ended

July 1, 2007

July 2, 2006

Cash
flows from operating activities:

Net income (loss)

$

(4,105

)

$

5,639

Adjustments to reconcile net income (loss) to net
cash used in operating activities:

Depreciation

11,486

7,459

Amortization of intangibles

14,551

2,350

Amortization of debt issuance costs

479



Impairment of acquisition-related intangibles

14,068



Stock-based compensation

23,833

2,549

Purchased in-process research and development

9,575



Loss on disposal of fixed assets



48

Deferred income taxes and other tax liabilities

(10,568

)

(940

)

Changes in operating assets and liabilities, net of
effects of acquisition:

Accounts receivable

(215

)

(8,765

)

Costs and estimated earnings in excess of billings

(14,323

)



Inventories

(49,438

)

(8,349

)

Prepaid expenses and other assets

(3,893

)

35

Deferred project costs

990



Advances to suppliers

(15,586

)

(19,176

)

Accounts payable and other accrued liabilities

14,169

11,675

Accounts payable to Cypress

2,993

729

Billings in excess of costs and estimated earnings

11,503



Advances from customers

(10,163

)

4,713

Net cash used in operating activities

(4,644

)

(2,033

)

Cash
flows from investing activities:

Decrease in restricted cash

4,711



Purchase of property, plant and equipment

(103,844

)

(33,384

)

Purchase of available-for-sale securities

(25,555

)

(22,900

)

Proceeds from sale of available-for-sale securities

16,496

3,000

Note receivable from PowerLight



(10,000

)

Cash paid for acquisition, net of cash acquired

(98,645

)



Net cash used in investing activities

(206,837

)

(63,284

)

Cash
flows from financing activities:

Proceeds from issuance of convertible debt

200,000



Convertible debt issuance costs

(6,030

)



Principal payments on line of credit and notes
payable

(3,563

)



Proceeds from issuance of common stock, net



197,431

Proceeds from exercise of stock options

4,969

1,787

Net cash provided by financing activities

195,376

199,218

Effect of exchange rate changes on cash and cash
equivalents

861



Net increase (decrease) in cash and cash equivalents

(15,244

)

133,901

Cash and cash
equivalents at beginning of period

165,596

143,592

Cash and cash
equivalents at end of period

$

150,352

$

277,493

Non-cash
investing and financing activities:

Issuance of common stock for purchase acquisition

$

111,266



Stock options
assumed in relation to acquisition

21,280



Change in
goodwill relating to adjustments to acquired net assets

1,689



The accompanying notes are
an integral part of these condensed consolidated financial statements.

5

SunPower
Corporation

Notes to Condensed Consolidated Financial Statements

Note 1. The Company
and Basis of Presentation

The Company

SunPower Corporation (the Company
or SunPower), a majority-owned subsidiary of Cypress Semiconductor
Corporation (Cypress), was originally incorporated in the State of California
on April 24, 1985. In October 1988, the Company organized as a business
venture to commercialize high-efficiency solar cell technologies. The Company
designs, manufactures and markets high-performance solar electric power
technologies. The Companys solar cells and solar panels are manufactured using
proprietary processes and technologies based on more than 15 years of research
and development. The Companys solar power products are sold through the
components business segment.

On November 10, 2005,
the Company reincorporated in Delaware and filed an amendment to its certificate
of incorporation to effect a 1-for-2 reverse stock split of the Companys
outstanding and authorized shares of common stock. All share and per share
figures presented herein have been adjusted to reflect the reverse stock split.

In November 2005, the Company
raised net proceeds of $145.6 million in an initial public offering (the IPO)
of 8.8 million shares of class A common stock at a price of $18.00 per
share. In June 2006, the Company completed a follow-on public offering of
7.0 million shares of its class A common stock, at a per share price of
$29.50, and received net proceeds of $197.4 million. In July 2007, the Company
completed a follow-on public offering of 2.7 million shares of its class A
common stock, at a discounted per share price of $64.50, and received net
proceeds of $167.7 million (see Note 16).

In February 2007, the
Company issued $200.0 million in principal amount of its 1.25% senior
convertible debentures and lent 2.9 million shares of its class A common stock
to Lehman Brothers Inc. Net proceeds from the issuance of senior convertible
debentures in February 2007 were $194.0 million. The Company did not receive
any proceeds from the 2.9 million lent shares of its class A common stock, but
received a nominal lending fee (see Note 15). In July 2007, the Company issued
$225.0 million in principal amount of its 0.75% senior convertible debentures
and lent 1.8 million shares of its class A common stock to Credit Suisse
International. Net proceeds from the
issuance of senior convertible debentures in July 2007 were $220.1 million. The
Company did not receive any proceeds from the 1.8 million lent shares of class
A common stock, but received a nominal lending fee (see Note 16).

In January 2007, the Company
completed the acquisition of PowerLight Corporation (PowerLight), a
privately-held company which developed, engineered, manufactured and delivered
large-scale solar power systems for residential, commercial, government and
utility customers worldwide. These activities are now performed by the Companys
systems business segment. As a result of the acquisition, PowerLight became an
indirect wholly owned subsidiary of the Company. In June 2007, the Company
changed PowerLights name to SunPower Corporation, Systems (SP Systems), to
capitalize on SunPowers name recognition. The Company believes the acquisition
will enable the Company to develop the next generation of solar products and
solutions that will accelerate solar system cost reductions to compete with retail
electric rates without incentives and simplify and improve customer experience.
The total consideration for the transaction was $334.4 million, consisting of
$120.7 million in cash and $213.7 million in common stock and related
acquisition costs (see Note 6).

Cypress made a significant
investment in the Company in 2002. On November 9, 2004, Cypress completed
a reverse triangular merger with the Company in which all of the outstanding
minority equity interest of SunPower was retired, effectively giving Cypress
100% ownership of all of the Companys then outstanding shares of capital stock
but leaving its unexercised warrants and options outstanding. After completion
of the Companys IPO in November 2005, Cypress held, in the aggregate,
52,033,287 shares of class B common stock. On May 4, 2007, Cypress
completed the sale of 7,500,000 shares of the Companys class B common stock in
an offering pursuant to Rule 144 of the Securities Act. Such shares converted
to 7,500,000 shares of class A common stock upon the sale. As of July 1,
2007, including the effect of the sale completed in May 2007 and the secondary
public offering in June 2006, Cypress owned 44,533,287 shares of the Companys
class B common stock, which represented approximately 59% of the total outstanding
shares of the Companys common stock, or approximately 55% of such shares on a
fully diluted basis after taking into account outstanding stock options (or 53%
of such shares on a fully diluted basis after taking into account outstanding
stock options and loaned shares to underwriters of the Companys convertible
indebtedness), and 91% of the voting
power of the Companys total outstanding common stock. After the public
offerings of class A common stock and senior convertible debentures on July 31,
2007, Cypress held approximately 57% of the total outstanding shares of the
Companys common stock, or approximately 53% of such shares on a fully diluted
basis after taking into account outstanding stock options (or 50% of such
shares on a fully diluted basis after taking into account outstanding stock
options and loaned shares to underwriters of the Companys convertible
indebtedness) and 90% of the voting power of the Companys total outstanding
common stock.

6

The financial statements
include allocations of certain Cypress expenses, including legal, tax,
treasury, information technology, employee benefits and other Cypress corporate
services and infrastructure costs. The expense allocations have been determined
based on a method that Cypress and the Company consider to be a reasonable
reflection of the utilization of services provided or the benefit received by
the Company. The financial information included herein may not be indicative of
the consolidated financial position, operating results, and cash flows of the
Company in the future, or what they would have been had the Company been a
separate stand-alone entity during the periods presented. See Note 8 for
additional information on the transactions with Cypress.

As of July 1, 2007, the
Company had an accumulated deficit of $36.1 million and, with the exception of
fiscal 2006 and the quarter ended April 1, 2007, has a history of operating
losses. The Company is subject to a number of business risks including, but not
limited to, integration difficulties as a result of the acquisition of SP
Systems, an industry-wide shortage of polysilicon, an essential raw material in
the production of solar cells, limited suppliers for capital equipment,
concentration of revenue among few customers, competition from other companies
with a longer operating history and significantly greater financial resources,
dependency on a third-party subcontractor, dependence on key employees, and the
ability to attract and retain additional qualified personnel.

Fiscal Year

The Company reports on a
fiscal-year basis and ends its quarters on the Sunday closest to the end of the
applicable calendar quarter, except in a 53-week fiscal year, in which case the
additional week falls into the fourth quarter of that fiscal year. Both fiscal
2006 and 2007 consist of 52 weeks. The second quarter of fiscal 2007 ended on
July 1, 2007 and the second quarter of fiscal 2006 ended on July 2,
2006.

Significant Accounting Policies

The Companys significant
accounting policies are disclosed in the Companys Form 10-K for the year ended
December 31, 2006 and have not changed materially as of July 1, 2007,
with the exception of the following:

In connection with the
acquisition of SP Systems on January 10, 2007, the following accounting
policies were adopted as of the quarter ended April 1, 2007.

Revenue and Cost
Recognition for Construction Contracts

The Company recognizes
revenues from fixed price contracts under AICPA Statement of Position (SOP)
81-1, Accounting for Performance of Construction-Type and Certain
Production-Type Contracts, using the percentage-of-completion method of
accounting. Under this method, revenue is recognized as work is performed based
on the percentage of incurred costs to estimated total forecasted costs
utilizing the most recent estimates of forecasted costs.

Incurred costs include all
direct material, labor, subcontract costs, and those indirect costs related to
contract performance, such as indirect labor, supplies, tools and repairs. Job
material costs are included in incurred costs when the job materials have been
installed. Where contracts stipulate that title to job materials transfers to
the customer before installation has been performed, revenue is deferred and
recognized upon installation, in accordance with the percentage-of-completion
method of accounting. Job materials are considered installed materials when
they are permanently attached or fitted to the solar power system as required
by the jobs engineering design.

Due to inherent
uncertainties in estimating cost, job costs estimates are reviewed and/or
updated by management working within the systems segment. The systems segment
determines the completed percentage of installed job materials at the end of
each month; generally this information is also reviewed with the customers
on-site representative. The completed percentage of installed job materials is
then used for each job to calculate the month-end job material costs incurred.
Direct labor, subcontractor, and other costs are charged to contract costs as
incurred. Provisions for estimated losses on uncompleted contracts, if any, are
recognized in the period in which the loss first becomes probable and
reasonably estimable. Contracts may include profit incentives such as milestone
bonuses. These profit incentives are included in the contract value when their
realization is reasonably assured.

As of July 1, 2007, the
asset Costs and estimated earnings in excess of billings, which represents
revenues recognized in excess of amounts billed, was $23.5 million. The
liability Billings in excess of costs and estimated earnings, which
represents billings in excess of revenues recognized, was $48.6 million.

Cash in
Restricted Accounts

Cash in restricted accounts
represents collateral for letters of credit issued by a commercial bank in
favor of Companys suppliers and customers. Generally, the funds will be
released upon payment to the suppliers and the successful completion of the
customer contracts. As of July 1, 2007, the Company did not have cash in
restricted accounts.

7

Deferred Project
Costs

Deferred project costs
represent uninstalled materials on contracts for which title had transferred to
the customer and are recognized as deferred assets until installation. As of
July 1, 2007, deferred project costs totaled $24.9 million.

Foreign Currency
Translation

Assets and liabilities of SP
Systems wholly-owned foreign subsidiaries are translated from their respective
functional currencies at exchange rates in effect at the balance sheet date,
and revenues and expenses are translated at average exchange rates prevailing
during the applicable period. The resulting translation adjustment as of
July 1, 2007 was $1.9 million and is reflected as a component of
accumulated other comprehensive income (loss) in stockholders equity.

Basis of Presentation

The accompanying condensed
consolidated interim financial statements have been prepared pursuant to the
rules and regulations of the Securities and Exchange Commission regarding
interim financial reporting. The year-end condensed balance sheet data was
derived from audited financial statements. Accordingly, these financial
statements do not include all of the information and footnotes required by
generally accepted accounting principles for complete financial statements and
should be read in conjunction with the Financial Statements and notes thereto
included in the Companys Annual Report on Form 10-K for the year ended
December 31, 2006. In the opinion of management, the accompanying
condensed consolidated financial statements contain all adjustments, consisting
only of normal recurring adjustments, which the Company believes are necessary
for a fair statement of the Companys financial position as of July 1,
2007 and its results of operations for the three and six months ended
July 1, 2007 and July 2, 2006, respectively. These condensed
consolidated financial statements are not necessarily indicative of the results
to be expected for the entire year.

Recent Accounting Pronouncements

In June 2006, the
Financial Accounting Standards Board (FASB) issued FASB Interpretation
No. 48, Accounting for Uncertainty in Income Taxes, and Related
Implementation Issues (FIN 48). FIN 48 clarifies the accounting
for uncertainty in income taxes recognized in a Companys financial statements
in accordance with FASB 109, Accounting for Income Taxes. FIN 48
prescribes a recognition threshold and measurement attribute for a tax position
taken or expected to be taken in a tax return. FIN 48 also provides
guidance on derecognition, classification, interest and penalties, accounting
in interim periods, disclosure, and transition. The Company adopted FIN 48
in the first quarter of fiscal 2007 (see Note 11).

In September 2006, the FASB
issued Statement of Financial Accounting Standards (SFAS) No. 157, Fair
Value Measurements (SFAS No. 157). SFAS No. 157 defines fair
value, establishes a framework for measuring fair value in accordance with
generally accepted accounting principles, and expands disclosures about fair
value instruments. This statement does not require any new fair value
measurements; rather, it applies under other accounting pronouncements that
require or permit fair value measurements. The provisions of this statement are
to be applied prospectively as of the beginning of the fiscal year in which
this statement is initially applied, with any transition adjustment recognized
as a cumulative effect adjustment to the opening balance of retained earnings.
The provisions of SFAS No. 157 are effective for fiscal years beginning
after November 15, 2007. The Company has not determined the effect, if
any, the adoption of this statement will have on its consolidated financial
statements.

In February 2007, the
FASB issued SFAS No. 159, The Fair Value Option for Financial Assets
and Financial Liabilities, (SFAS No. 159) which provides companies an option
to report selected financial assets and liabilities at fair value. SFAS No. 159
requires companies to provide information helping financial statement users to
understand the effect of a companys choice to use fair value on its earnings,
as well as to display the fair value of the assets and liabilities a company
has chosen to use fair value for on the face of the balance
sheet. Additionally, SFAS No. 159 establishes presentation and
disclosure requirements designed to simplify comparisons between companies that
choose different measurement attributes for similar types of assets and
liabilities. The statement is effective as of the beginning of an entitys
first fiscal year beginning after November 15, 2007. The Company has
not determined the effect, if any, the adoption of this statement will have on
its consolidated financial statements.

8

Note 2. Balance Sheet
Components

(In thousands)

July 1,
2007

December 31,
2006

Inventories:

Raw materials*

$

52,970

$

8,703

Work-in-process

1,314

79

Finished goods

46,487

13,998

$

100,771

$

22,780

* Raw materials include solar panels purchased from
third party vendors, installation materials for systems projects, polysilicon
and other raw materials for solar cell manufacturing as of July 1, 2007.

Prepaid expenses and other current assets:

Deferred tax asset,
current portion

$

7,501

$

1,446

Note receivable from PowerLight



10,000

Unbilled earned rebates

5,168



Prepaid materials

4,531



VAT receivable, current
portion

2,651

48

Prepaid corporate
insurance

1,306

460

Other receivables

7,675

1,452

Other prepaid expenses

6,063

3,249

$

34,895

$

16,655

Property, plant and equipment, net:

Land and buildings

$

7,482

$

7,304

Manufacturing equipment

129,718

120,104

Computer equipment

8,091

2,496

Furniture and fixtures

152

83

Leasehold improvements

49,598

45,175

Construction-in-process
(manufacturing facility in the Philippines)

138,287

53,252

333,328

228,414

Less: Accumulated
depreciation and amortization

(37,552

)

(25,986

)

$

295,776

$

202,428

Intangible assets:

Patents and purchased
technology

$

51,398

$

21,950

Tradenames

1,603

1,603

Backlog

11,787



Customer relationships
and other

23,193

463

87,981

24,016

Accumulated amortization of intangible assets:

Patents and purchased
technology

(14,562

)

(8,973

)

Tradenames

(678

)

(548

)

Backlog

(5,566

)



Customer relationships
and other

(2,239

)

(446

)

(23,045

)

(9,967

)

$

64,936

$

14,049

The estimated
future amortization expense related to intangible assets as of July 1, 2007
is as follows:

2007 (remaining six months)

$

13,716

2008

15,350

2009

14,740

2010

13,228

2011 and beyond

7,902

$

64,936

9

(In thousands)

July 1,
2007

December 31,
2006

Other long-term assets:

Investment in joint
venture

$

4,792

$

4,994

Debt issuance costs

5,559



VAT receivable, net of
current portion

12,751



Other

502

1,639

$

23,604

$

6,633

Accrued liabilities:

Warranty reserve,
current portion

$

8,460

$

3,446

Employee compensation
and employee benefits

13,488

3,961

Foreign exchange derivative
liability

3,559

4,849

Income taxes payable

4,681

1,995

Other

10,019

4,334

$

40,207

$

18,585

Long-term liabilities:

Warranty reserve, net
of current portion

$

5,854

$



Other

1,727



$

7,581

$



Note 3. Investments

Cash and cash equivalents
and short-term investments classified as available-for-sale securities were
comprised of the following:

July 1, 2007

December 31, 2006

Unrealized

Unrealized

(In thousands)

Cost

Gross
Gains

Gross
Losses

Fair
Value

Cost

Gross
Gains

Gross
Losses

Fair
Value

Corporate securities

$

9,600

$



$



$

9,600

$

13,400

$



$



$

13,400

Money market securities

95,425





95,425

135,298





135,298

Commercial paper

38,388





38,388

28,739



(4

)

28,735

Total
available-for-sale securities

$

143,413

$



$



$

143,413

$

177,437

$



$

(4

)

$

177,433

The classification and
contractual maturities of available-for-sale securities is as follows:

(In thousands)

July 1, 2007

December 31, 2006

Included in:

Cash and cash
equivalents

$

117,858

$

160,937

Short-term investments

25,555

16,496

$

143,413

$

177,433

Contractual maturities:

Due in less than one
year

$

133,813

$

164,033

Due from one to 30
years

9,600

13,400

$

143,413

$

177,433

10

From time to time the
Company invests in auction rate securities, which are bought and sold in the
marketplace through a bidding process sometimes referred to as a Dutch
Auction, and which are classified as short-term investments and carried at
their market values. After the initial issuance of the securities, the interest
rate on the securities resets periodically, at intervals set at the time of
issuance (e.g., every seven, twenty-eight, or thirty-five days; every six
months; etc.), based on the market demand at the reset period. The stated or contractual
maturities for these securities, however, generally are 20 to 30 years. Despite
the long-term maturities, the Company has the ability and intent, if necessary,
to liquidate any of these investments in order to meet the Companys working
capital needs within its normal operating cycles. At July 1, 2007, the Company
had $9.6 million invested in auction rate securities as compared to $13.4
million invested in auction rate securities at December 31, 2006.

The Company classifies these
investments as available-for-sale securities under Statement of Financial
Accounting Standards No. 115 Accounting for Investment in Certain Debt
and Equity Securities (SFAS No. 115). As these securities trade at their
par values, no gains or losses are recorded in comprehensive income.

Note 4. Net Income
(Loss) per Share

Basic net income (loss) per
share is computed using the weighted-average common shares outstanding. Diluted
net income (loss) per share is computed using the weighted-average common
shares outstanding plus any potentially dilutive securities outstanding during
the period using the treasury stock method, except when their effect is
anti-dilutive. In computing dilutive net income (loss) per share, the average
stock price for the period is used in determining the number of shares assumed
to be purchased from the exercise of stock options or warrants. Dilutive
securities include stock options and restricted stock. As of July 1, 2007,
holders of the $200.0 million in principal amount of the Companys 1.25% senior
convertible debentures issued in February 2007 did not have the right to
convert the debentures into shares of the Companys class A common stock (see
Note 15). Therefore, the senior
convertible debentures are excluded from the summary of all outstanding
anti-dilutive potential common shares in the table below.

The following is a summary
of all outstanding anti-dilutive potential common shares:

As of

(In thousands)

July 1, 2007

July 2, 2006

Stock options

142

74

Restricted stock

300



The following table sets
forth the computation of basic and diluted weighted-average common shares:

Three Months Ended

Six
Months Ended

(In
thousands)

July 1, 2007

July 2, 2006

July 1, 2007

July 2, 2006

Basic
weighted-average common shares

75,123

64,040

74,428

62,583

Effect of
dilutive securities:

Stock options



5,317



5,555

Restricted stock



51



34

Weighted-average
common shares for diluted computation

75,123

69,408

74,428

68,172

Basic weighted-average
common shares includes 1.1 million shares of class A common stock issued in
relation to the acquisition of SP Systems which are subject to certain transfer
restrictions and a repurchase option by the Company, both of which lapse on one
quarter of the shares semi-annually over a two-year period. In addition, basic
weighted-average common shares excludes 2.9 million shares of class A common
stock lent to Lehman Brothers Inc. in connection with the issuance of $200.0
million in principal amount of its 1.25% senior convertible debentures in
February 2007 (see Note 15).

Note 5. Comprehensive
Income (Loss)

Comprehensive income (loss)
is defined as the change in equity of a business enterprise during a period
from transactions and other events and circumstances from non-owner sources.
Comprehensive income (loss) includes unrealized gains and losses on the Companys
available-for-sale investments, derivatives and cumulative translation adjustments.

The components of
comprehensive income (loss), net of tax, were as follows:

Three Months Ended

Six Months Ended

(In thousands)

July 1, 2007

July 2, 2006

July 1, 2007

July 2, 2006

Net income (loss)

$

(5,345

)

$

5,384

$

(4,105

)

$

5,639

Cumulative translation adjustment

1,561



1,897



Unrealized gain (loss) on derivatives, net of tax

349

(1,429

)

804

(2,305

)

Total
comprehensive income (loss)

$

(3,435

)

$

3,955

$

(1,404

)

$

3,334

11

Note 6. Business
Combinations

PowerLight Acquisition

On January 10, 2007
(the Effective Date), the Company completed its merger transaction (the Merger)
involving PowerLight. The results of PowerLight have been included in the
consolidated results of the Company from January 10, 2007. As a result of
the Merger, all of the outstanding shares of PowerLight, and a portion of each
vested option to purchase shares of PowerLight, were cancelled, and all of the
outstanding options to purchase shares of PowerLight (other than the portion of
each vested option that was cancelled) were assumed by the Company in exchange
for aggregate consideration of (i) approximately $120.7 million in cash
plus (ii) a total of 5,708,723 shares of the Companys class A common
stock, inclusive of (a) 1,601,839 shares of the Companys class A common
stock which may be issued upon the exercise of assumed vested and unvested
PowerLight stock options, which options vest on the same schedule as the
assumed PowerLight stock options, and (b) 1,145,643 shares of the Companys
class A common stock issued to employees of PowerLight in connection with the
Merger which, along with 530,238 of the shares issuable upon exercise of
assumed PowerLight stock options, are subject to certain transfer restrictions
and a repurchase option by the Company, both of which lapse over a two-year
period under the terms of certain equity restriction agreements. The Company
under the terms of the Merger agreement also issued an additional 204,623
shares of restricted class A common stock to certain employees of PowerLight,
which shares are subject to certain transfer restrictions which will lapse over
4 years. In June 2007, the Company changed PowerLights name to SunPower
Corporation, Systems, or SP Systems, to capitalize on SunPowers name recognition.

The total consideration
related to the acquisition is as follows:

(In thousands)

Shares

Fair Value at
January 10, 2007

Purchase consideration:

Cash



$

120,694

Common stock

2,961

111,266

Stock options assumed
that are fully vested

618

21,280

Direct transaction
costs



2,958

Total purchase
consideration

3,579

256,198

Future stock compensation:

Restricted stock

1,146

43,046

Stock options assumed
that are unvested

984

35,126

Total future stock
compensation

2,130

78,172

Total purchase consideration and future stock
compensation

5,709

$

334,370

Purchase Price Allocation

Under the purchase method of
accounting, the total purchase price as shown in the table above was allocated
to SP Systems net tangible and intangible assets based on their estimated fair
values as of the Effective Date. The purchase price has been allocated based on
managements best estimates. The fair value of the Companys class A common
stock issued was determined based on the average closing prices for a range of
trading days around the announcement date (November 15, 2006) of the
transaction. The fair value of stock options assumed was estimated using the
Black-Scholes model with the following assumptions: volatility of 90%, expected
life ranging from 2.7 years to 6.3 years, and risk-free interest rate of 4.6%.

12

The allocation of the
purchase price and the estimated useful lives associated with certain assets on
January 10, 2007 was as follows:

(In thousands)

Amount

Estimated
Useful
Life

Net tangible assets

$

13,925

n.a.

Patents and purchased
technology

29,448

4 years

Tradenames

15,535

5 years

Backlog

11,787

1 year

Customer relationships

22,730

6 years

In-process research and
development

9,575

n.a.

Unearned stock
compensation

78,172

n.a.

Deferred tax liability

(21,964

)

n.a.

Goodwill

175,162

n.a.

Total purchase consideration and future stock
compensation

$

334,370

Net tangible assets acquired
on January 10, 2007 consisted of the following:

(In thousands)

Amount

Cash and cash
equivalents

$

22,049

Restricted cash

4,711

Accounts receivable,
net

40,080

Costs and estimated
earnings in excess of billings

9,136

Inventories

28,146

Deferred project costs

24,932

Prepaid expenses and
other assets

23,740

Total assets acquired

152,794

Accounts payable

(60,707

)

Billings in excess of
costs and estimated earnings

(35,887

)

Other accrued expenses
and liabilities

(42,275

)

Total liabilities
assumed

(138,869

)

Net assets acquired

$

13,925

Acquired
identifiable intangible assets. The fair value attributed to purchased technology and patents was
determined using the relief from royalty method, which calculated the present
value of the royalty savings by applying a royalty rate of 2.5% and a discount
rate of 25% to the appropriate revenue streams. The fair value of purchased
technology and patents is being amortized over 4 years on a straight-line
basis. Amortization expense for the three and six months ended July 1,
2007 was as follows:

(In thousands)

Three Months
Ended

Six Months
Ended

Cost of systems revenue

$

5,564

$

10,510

Selling, general and
administrative

947

1,789

Total amortization
expense

$

6,511

$

12,299

The fair value of tradenames
was determined using the royalty savings approach method, using a royalty rate
of 1% and a discount rate of 25%. The fair value of tradenames was valued at
$15.5 million and ascribed a useful life of 5 years. The determination of the
fair value and useful life of the tradename was based on the Companys strategy
of continuing to market its systems products and services under the PowerLight
brand. Based on the Companys change in branding strategy, during the three-month
period ended July 1, 2007, the Company recognized an impairment charge of $14.1
million, which represented the net book value of the PowerLight tradename.

The fair value
attributed to customer relationships was determined using the multi-period
excess earnings method with a discount rate of 22%. The fair value of customer
relationships is being amortized over 6 years on a straight-line basis.

The fair value attributed to
order backlog was determined using the multi-period excess earnings method with
a discount rate of 20%. The fair value of order backlog is being amortized over
1 year on a straight-line basis.

13

In-process
research and development.
SP Systems in-process research and development primarily consists of two
components, design automation tool and tracking systems and other, which have
not yet reached technological feasibility and have no alternative future uses.

Goodwill. Approximately $175.2 million had been
allocated to goodwill within the systems segment, which represents the excess
of the purchase price over the fair value of the underlying net tangible and
intangible assets of SP Systems. In accordance with SFAS No. 142, Goodwill
and Other Intangible Assets, goodwill will not be amortized but instead will
be tested for impairment at least annually (more frequently if certain
indicators are present). In the event that management determines that the value
of goodwill has become impaired, the Company will incur an accounting charge
for the amount of the impairment during the fiscal quarter in which the
determination is made. During the three months ended July 1, 2007, the Company
recorded a $1.7 million adjustment to increase goodwill acquired in connection
with the purchase of SP Systems on January 10, 2007. This adjustment was
recorded to reflect an additional loss provision on a construction project that
was contracted as of the acquisition date and which has subsequently been determined
to have a larger loss than originally estimated as well as adjustments to the
value of certain acquired assets and liabilities. Goodwill that resulted from
the acquisition of SP Systems is not deductible for tax purposes.

Of the cash and shares
issued in the acquisition, approximately $20.5 million in cash and 824,000
shares, with a total aggregate value of $72.5 million as of July 1, 2007, are
being held in escrow as security for the indemnification obligations of certain
former SP Systems shareholders and will be released over a period of five years
from the date of acquisition. In addition, the Company issued an additional
204,623 shares of restricted class A common stock to certain employees of SP Systems,
which shares are subject to certain transfer restrictions that lapse over four
years.

In conjunction with the
acquisition, Cypress entered into a commitment letter with the Company during
the fourth quarter of fiscal 2006 under which Cypress agreed to lend to the
Company up to $130.0 million in cash to be used to facilitate the financing of
the acquisition or working capital requirements. In February 2007, Cypress and the
Company mutually terminated the commitment letter. No borrowings were
outstanding at the termination date.

The Company accounted for
its acquisition of SP Systems in accordance with SFAS 141, Business
Combinations. Accordingly, all intercompany receivables and payables related
to SP Systems were eliminated in purchase accounting effective January 10,
2007.

Supplemental information on
an unaudited pro forma basis, as if the acquisition of SP Systems were
completed at the beginning of the years 2007 and 2006, is as follows:

Three Months Ended

Six Months Ended

(In thousands, except per share amounts)

July 1, 2007

July 2, 2006

July 1, 2007

July 2, 2006

Revenue

$

173,766

$

88,433

$

318,427

$

157,016

Net loss

$

(5,345

)

$

(20,124

)

$

(6,213

)

$

(41,504

)

Basic net loss per share

$

(0.07

)

$

(0.30

)

$

(0.08

)

$

(0.63

)

The unaudited pro forma
supplemental information is based on estimates and assumptions, which the
Company believes are reasonable. The unaudited pro forma supplemental
information includes non-recurring in-process research and development charge
of $9.6 million recorded in the first quarter ended April 1, 2007 and April 2,
2006. The unaudited pro forma supplemental information prepared by management
is not necessarily indicative of the condensed consolidated financial position
or results of income in future periods or the results that actually would have
been realized had the Company and SP Systems been a combined company during the
specified periods.

In-Process Research and Development
(IPR&D) Charge

In connection with the
acquisition of SP Systems, the Company recorded an IPR&D charge of $9.6
million in the first quarter of fiscal 2007, as technological feasibility
associated with the in-process research and development projects had not been
established and no alternative future use existed.

The Company identified
in-process research and development projects in areas for which technological
feasibility had not been established and no alternative future use existed.
These in-process research and development projects consist of two components:
design automation tool and tracking systems and other. In assessing the
projects, the Company considered key characteristics of the technology as well
as its future prospects, the rate technology changes in the industry, product
life cycles, and various projects stage of development.

14

The value of in-process
research and development was determined using the income approach method, which
calculated the sum of the discounted future cash flows attributable to the
projects once commercially viable using a 40% discount rate, which were derived
from a weighted-average cost of capital analysis and adjusted to reflect the
stage of completion of the projects and the level of risks associated with the
projects. The percentage of completion for each project was determined by
identifying the research and development expenses invested in the project as a
ratio of the total estimated development costs required to bring the project to
technical and commercial feasibility. The following table summarizes certain
information of each significant project:

Design Automation Tool

Stage
of Completion

Total Cost Incurred
to Date

Total Costs
for the Project

Completion Date

As of January 10,
2007(acquisition date)

5%

$

0.2 million

$

2.6 million

Dec
2010

As of July 1, 2007

30%

$

0.8 million

$

2.6 million

Jun 2008

Tracking System and Other

Stage
of Completion

Total Cost Incurred
to Date

Total Costs
for the Project

Completion Date

As of January 10, 2007
(acquisition date)

30%

$

0.2 million

$

0.8 million

Jul
2007

As of July 1, 2007

100%

$

0.8 million

$

0.8 million

Jun 2007

Status of In-Process Research and
Development Projects:

As of July 1, 2007, the
Company has incurred total post-acquisition costs of approximately $0.6 million
related to the design automation tool project and estimates that an additional
investment of $1.8 million will be required to complete the project. The Company
expects to complete the design automation tool project by June 2008,
approximately two and a half years earlier than the original estimate.

During the second quarter of
fiscal 2007, the Company has completed the tracking systems project and
incurred total project costs of $0.8 million, of which $0.6 million was
incurred after the acquisition.

The development of the
design automation tool remains a significant risk due to factors including the
remaining efforts to achieve technical viability, rapidly changing customer
markets, uncertain standards for new products, and competitive threats. The
nature of the efforts to develop these technologies into commercially viable
products consists primarily of planning, designing, experimenting, and testing
activities necessary to determine that the technologies can meet market
expectations, including functionality and technical requirements. Failure to
bring these products to market in a timely manner could result in a loss of
market share or a lost opportunity to capitalize on emerging markets and could
have a material adverse impact on the Companys business and operating results.

Note 7. Advances to
Suppliers and Other Current Assets

The Company has entered into
agreements with various polysilicon, ingot, wafer, solar cells and solar module
vendors and manufacturers. These agreements specify future quantities and
pricing of products to be supplied by the vendors for periods up to 13 years.
Certain agreements also provide for penalties or forfeiture of advanced deposits
in the event the Company terminates the arrangements (see Note 13).

Furthermore, under certain
of these agreements, the Company is required to make prepayments to the vendors
over the terms of the arrangements. In the second quarter of fiscal 2007, the Company
paid advances totaling $15.6 million in accordance with the terms of existing
supply agreements. The Company may also, from time to time, make advance
payments in connection with purchases of services and manufacturing equipment
from a variety of vendors and suppliers. As of July 1, 2007, advances to
suppliers totaled $93.2 million, the current portion of which is $10.2 million.

The Companys future
prepayment obligations related to these agreements as of July 1, 2007 and
inclusive of prepayment obligations entered into on July 16, 2007 (see Note 16)
are as follows (in thousands):

2007 (remaining six months)

$

60,490

2008

56,040

2009

48,840

2010

11,100

$

176,470

On July 2, 2007, the Company
paid an additional advance of $10.0 million in accordance with the terms of an
existing supply agreement.

Note 8. Transactions
with Cypress

Purchases of Imaging and Infrared
Detector Products from Cypress

The Company purchases wafers
from Cypress at intercompany prices which are consistent with Cypress internal
transfer pricing methodology.

15

Manufacturing Services in Texas

The Company originally made
its imaging and infrared detector and solar power products at its former
Sunnyvale, California facility. In May 2002, the Company installed
certain tenant improvements to build a pilot wafer fabrication line for a newly
designed solar cell in a Cypress facility located in Texas. The Company then
paid pro rata costs for materials and Cypress personnel to operate the facility
which made the Companys pre-commercial production solar cells until the
Philippines facility came on line in November 2004. In late 2004, the Company
moved its imaging and infrared detector production lines to the Cypress Texas
facility and continues to pay the costs of materials and Cypress personnel to
operate the facility.

Administrative Services Provided by
Cypress

Cypress has seconded
employees and consultants to the Company for different time periods for which
the Company pays their fully-burdened compensation. In addition, Cypress
personnel render services to the Company to assist with administrative
functions such as legal, tax, treasury, information technology, employee
benefits and other Cypress corporate services and infrastructure. Cypress bills
the Company for a portion of the Cypress employees fully-burdened
compensation. In the case of the Philippines subsidiary, which entered into a
services agreement for such secondments and other consulting services in
January 2005, the Company pays the fully-burdened compensation plus 10%.
Amounts paid for these services are recorded as general and administrative
expenses in the accompanying statements of operations.

Leased Facility in the Philippines

In 2003, the Company and
Cypress reached an understanding that the Company would build out and occupy a
building owned by Cypress for its wafer fabrication facility in the
Philippines. The Company entered into a lease agreement for this facility,
which expires in July 2021. Under the lease, the Company will pay Cypress at a
rate equal to the cost to Cypress for that facility (including taxes,
insurance, repairs and improvements) until the earlier of November 2015 or a
change in control of the Company occurs, which includes such time as Cypress
ceases to own at least a majority of the aggregate number of shares of all
classes of the Companys common stock then outstanding. Thereafter, the Company
will pay market rate rent for the facility. The Company will have the right to
purchase the facility from Cypress at any time at Cypress original purchase
price of approximately $8.0 million, plus interest computed on a variable index
starting on the date of purchase by Cypress until the sale to the Company,
unless such purchase option is exercised after a change of control of the
Company, in which case the purchase price shall be at a market rate, as
reasonably determined by Cypress. The lease agreement also contains certain
indemnification and exculpation provisions by the Company for the benefit of
Cypress as lessor.

Leased Facility in California

On May 15, 2006, the
Company entered into a lease agreement for its 43,732 square foot headquarters,
which is located in a building owned by Cypress in San Jose, California, for
$6.0 million over the five-year term of the lease. On July 1, 2007, the
Company entered into an amendment to the lease agreement, increasing the
rentable square footage and the total lease obligations to 51,228 and $7.1
million, respectively, over the five-year term of the lease. In the event
Cypress decides to sell the building, the Company has the right of first
refusal to purchase the building at a fair market price which will be based on
comparable sales in the area.

Purchases of imaging and
infrared detector products from Cypress, manufacturing services provided by
Cypress in Texas, administrative services provided by Cypress and the
facilities leased from Cypress in the Philippines and in California aggregated
$2.2 million and $4.5 million for the three and six months ended July 1, 2007,
respectively, and $3.3 million and $6.1 million for the three and six months
ended July 2, 2006, respectively.

2005 Separation and Service
Agreements

On October 6, 2005, the
Company entered into a series of separation and services agreements with
Cypress. Among these agreements are a master separation agreement, a sublease
of the land and a lease for the building in the Philippines (see above); a
three-year wafer manufacturing agreement for detector products at inter-company
pricing; a three-year master transition services agreement under which Cypress
would allow the Company to continue to utilize services provided by Cypress
such as corporate accounting, legal, tax, information technology, human resources
and treasury administration at Cypress cost; an asset lease under which
Cypress will lease certain manufacturing assets from the Company; an employee
matters agreement under which the Companys employees would be allowed to
continue to participate in certain Cypress health insurance and other employee
benefits plans; an indemnification and insurance matters agreement; an investor
rights agreement; and a tax sharing agreement. All of these agreements, except
the tax sharing agreement and the manufacturing asset lease agreement, became
effective at the time of completion of the Companys initial public offering in
November 2005.

Master Separation Agreement

In October 2005, the Company
entered into a master separation agreement containing the framework with
respect to the Companys separation from Cypress. The master separation
agreement provides for the execution of various ancillary agreements that
further specify the terms of the separation.

16

Wafer Manufacturing Agreement

The Company has entered into
an agreement with Cypress to continue to make infrared and imaging detector
products for the Company at prices consistent with the then current Cypress
transfer pricing, which is equal to the forecasted cost to Cypress to
manufacture the wafers, for the earlier of the next three years or until a
change in control of the Company occurs, which includes until such time as
Cypress ceases to own at least a majority of the aggregate number of shares of
all classes of the Company common stock then outstanding, after which a new
supply agreement may be negotiated or the Company and Cypress will negotiate a
reasonable winding-up procedure. In addition, the Company may use other Cypress
fabs for development work on a cost per activity basis.

The Company will indemnify
Cypress for any liabilities that arise only to the extent that they are based
on claims of infringement based on the Companys design specifications that the
Company submits to Cypress for the manufacture of the Companys products.
Cypress will indemnify the Company for liabilities that arise only to the
extent that they are based on claims that the manufacturing, assembling,
product testing or packaging process that Cypress uses for the Companys
products infringes or violates upon the intellectual property rights of third
parties or Cypress unauthorized use of the Companys design specifications or
proprietary information.

Master Transition Services
Agreement

The Company has also entered
into a master transition services agreement which would govern the provisions
of services to us by Cypress, such as: financial services, human resources,
legal matters, training programs, and information technology.

For a period of three years
following the Companys November 2005 initial public offering of 8.8 million
shares of class A common stock (IPO) or earlier if a change of control of the
Company occurs, Cypress would provide these services and the Company would pay
Cypress for services provided to the Company, at Cypress cost (which, for
purposes of the master transition services agreement, will mean an appropriate
allocation of Cypress full salary and benefits costs associated with such
individuals as well as any out-of-pocket expenses that Cypress incurs in
connection with providing the Company with those services) or at the rate
negotiated with Cypress. Cypress will have the ability to deny requests for
services under this agreement if, among other things, the provisions of such
services creates a conflict of interest, causes an adverse consequence to Cypress,
requires Cypress to retain additional employees or other resources or the
provision of such services become impracticable as a result or cause outside of
the control of Cypress. In addition, Cypress will incur no liability in
connection with the provision of these services. The master transition services
agreement also contains certain indemnification provisions by the Company for
the benefit of Cypress.

Lease for Manufacturing Assets

In 2005 the Company entered
into a lease with Cypress under which Cypress leases from the Company certain
manufacturing assets owned by the Company and located in Cypress Texas
manufacturing facility. The term of the lease is 27 months and it expires on
December 31, 2007. Under this lease, Cypress is reimbursing the Companys
cost of approximately $0.7 million divided over the life of the leasehold
improvements.

Employee Matters Agreement

The Company entered into an
employee matters agreement with Cypress to allocate assets, liabilities and
responsibilities relating to its current and former U.S. and international
employees and its employees participation in the employee benefits plans that
Cypress sponsors and maintains.

The Companys eligible
employees generally remain able to participate in Cypress benefit plans, as they
may change from time to time. The Company is responsible for all liabilities
incurred with respect to the Cypress plans by the Company as a participating
company in such plans. The Company intends to have its own benefit plans
established by the time its employees no longer are eligible to participate in
Cypress benefit plans. Once the Company has established its own benefit plans,
the Company will have the ability to modify or terminate each plan in
accordance with the terms of those plans and the Companys policies. It is the
Companys intent that employees not receive duplicate benefits as a result of
participation in its benefit plans and the corresponding Cypress benefit plans.

All of the Companys
eligible employees are able to continue to participate in Cypress health
plans, life insurance and other benefit plans as they may change from time to
time, until the earliest of, (1) a change of control of the Company
occurs, which includes such time as Cypress ceases to own at least a majority
of the aggregate number of shares of all classes of the Companys common stock
then outstanding, (2) such time as the Companys status as a participating
company under the Cypress plans is not permitted by a Cypress plan or by
applicable law, (3) such time as Cypress determines in its reasonable
judgment that the Companys status as a participating company under the Cypress
plans has or will adversely affect Cypress, or its employees, directors,
officers, agents, affiliates or its representatives, or (4) such earlier
date as the Company and Cypress mutually agree. However, to avoid redundant
benefits, the Companys employees will generally be precluded from
participating in Cypress stock option plans and stock purchase plans.

17

With respect to the Cypress
401(k) Plan, the Company is obligated to establish its own 401(k) Plan within
90 days of separation from Cypress, and Cypress will transfer all accounts in
the Cypress 401(k) Plan held by the Companys employees to the Companys 401(k)
Plan.

Indemnification and Insurance
Matters Agreement

The Company will indemnify
Cypress and its affiliates, agents, successors and assigns from all liabilities
arising from environmental conditions existing on, under, about or in the
vicinity of any of the Companys facilities, or arising out of operations
occurring at any of the Companys facilities, including the California
facilities, whether prior to or after the separation; existing on, under, about
or in the vicinity of the Philippines facility which the Company occupies, or
arising out of operations occurring at such facility, whether prior to or after
the separation, to the extent that those liabilities were caused by the
Company; arising out of hazardous materials found on, under or about any
landfill, waste, storage, transfer or recycling site and resulting from
hazardous materials stored, treated, recycled, disposed or otherwise handled by
any of the Companys operations or the Companys California and Philippines
facilities prior to the separation; and arising out of the construction
activity conducted by or on behalf of the Company at Cypress Texas facility.

The indemnification and
insurance matters agreement and the master transition services agreement also
contain provisions governing the Companys insurance coverage, which are under
the Cypress insurance policies (other than the Companys directors and officers
insurance, for which the Company has its own separate policy) until the
earliest of (1) a change of control of the Company, which includes such
time as Cypress ceases to own at least a majority of the aggregate number of
shares of all classes of the Companys common stock then outstanding,
(2) the date on which Cypress insurance carriers do not permit the
Company to remain on Cypress policies, (3) the date on which Cypress cost
of insurance under any particular insurance policy increases, directly or
indirectly, due to the Companys inclusion or participation in such policy,
(4) the date on which the Companys coverage under the Cypress policies
causes a real or potential conflict of interest or hardship for Cypress, as
determined solely by Cypress or (5) the date on which Cypress and the
Company mutually agree to terminate this arrangement. Prior to that time,
Cypress will maintain insurance policies on the Companys behalf, and the
Company shall reimburse Cypress for expenses related to insurance coverage
during this period. The Company will work with Cypress to secure additional
insurance if desired and cost effective.

Investor Rights Agreement

The Company has entered into
an investor rights agreement with Cypress providing for specified
(1) registration and other rights relating to the Companys shares of the
Companys common stock, (2) information and inspection rights,
(3) coordination of auditing practices and (4) approval rights with
respect to certain transactions.

Tax Sharing Agreement

The Company has entered into
a tax sharing agreement with Cypress providing for each of the partys
obligations concerning various tax liabilities. The tax sharing agreement is structured
such that Cypress will pay all federal, state, local and foreign taxes that are
calculated on a consolidated or combined basis (while being a member of Cypress
consolidated or combined group pursuant to federal, state, local and foreign
tax law). The Companys portion of such tax liability or benefit will be
determined based upon its separate return tax liability as defined under the
tax sharing agreement. Such liability or benefit will be based on a pro forma
calculation as if the Company were filing a separate income tax return in each
jurisdiction, rather than on a combined or consolidated basis with Cypress
subject to adjustments as set forth in the tax sharing agreement.

After the date the Company
ceases to be a member of Cypress consolidated group for federal income tax
purposes or state income tax purposes, as and to the extent that the Company
becomes entitled to utilize on the Companys separate tax returns portions of
those credit or loss carryforwards existing as of such date, the Company will
distribute to Cypress the tax effect, estimated to be 34% for federal income
tax purposes, of the amount of such tax loss carryforwards so utilized, and the
amount of any credit carryforwards so utilized. The Company will distribute
these amounts to Cypress in cash or in the Companys shares, at the Companys
option. As of December 31, 2006, the Company has approximately $50.6
million of federal net operating loss carryforwards and approximately $4.8
million of California net operating loss carryforwards meaning that such
potential future payments to Cypress, which would be made over a period of
several years, would therefore aggregate approximately $15.0 million.

Upon completion of its
follow-on public offering of common stock in June 2006, the Company is no
longer considered to be a member of Cypress consolidated group for federal
income tax purposes. Accordingly, the Company will be subject to the
obligations payable to Cypress for any federal income tax credit or loss
carryforwards utilized in its federal tax returns in subsequent periods, as
explained in the preceding paragraph.

The Company will continue to
be jointly and severally liable for any tax liability as governed under
federal, state and local law during all periods in which it is deemed to be a
member of the Cypress consolidated or combined group. Accordingly, although the
tax sharing agreement allocates tax liabilities between Cypress and all its
consolidated subsidiaries, for any period in which the Company is included in
Cypress consolidated group, the Company could be liable in the event that any
federal tax liability was incurred, but not discharged, by any other member of
the group.

18

If Cypress distributes the
Companys class B common stock to Cypress stockholders in a transaction
intended to qualify as a tax-free distribution under Section 355 of the
Code, Cypress intends to obtain an opinion of counsel and/or a ruling from the
Internal Revenue Service to the effect that such distribution qualifies under
Section 355 of the Code. Despite such an opinion or ruling, however, the
distribution may nonetheless be taxable to Cypress under Section 355(e) of
the Code if 50% or more of the Companys voting power or economic value is
acquired as part of a plan or series of related transactions that includes the
distribution of the Companys stock. The tax sharing agreement includes the
Companys obligation to indemnify Cypress for any liability incurred as a
result of issuances or dispositions of the Companys stock after the
distribution, other than liability attributable to certain dispositions of the
Companys stock by Cypress, that cause Cypress distribution of shares of the
Companys stock to its stockholders to be taxable to Cypress under
Section 355(e) of the Code.

The tax sharing agreement
further provides for cooperation with respect to tax matters, the exchange of
information and the retention of records which may affect the income tax
liability of either party. Disputes arising between Cypress and us relating to
matters covered by the tax sharing agreement are subject to resolution through
specific dispute resolution provisions contained in the agreement.

Note 9. Foreign
Currency Derivatives

The Company has non-U.S.
subsidiaries that operate and sell the Companys products in various global
markets, primarily in Europe. As a result, the Company is exposed to risks
associated with changes in foreign currency exchange rates. It is the Companys
policy to use various hedge instruments to manage the exposures associated with
purchases of foreign sourced equipment, net asset or liability positions of its
subsidiaries and forecasted revenues and expenses. The Company does not enter
into foreign currency derivative financial instruments for speculative or
trading purposes.

As of July 1, 2007, the
Companys hedge instruments consisted of foreign currency option contracts and
foreign currency forward exchange contracts. The Company calculates the fair
value of its option and forward contracts based on market volatilities, spot
rates and interest differentials from published sources.

In accordance with Statement
of Financial Accounting Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities, the Company accounts for its hedges of
forecasted foreign currency revenues as cash flow hedges and hedges of firmly
committed purchase contracts denominated in foreign currency as fair value
hedges.

Cash Flow Hedges: Hedges of
forecasted foreign currency denominated revenues are designated as cash flow
hedges and changes in fair value of the effective portion of hedge contracts
are recorded in accumulated other comprehensive income (loss) in stockholders
equity in the Condensed Consolidated Balance Sheets. Amounts deferred in
accumulated other comprehensive income (loss) are reclassified into the
Condensed Consolidated Statement of Operations in the periods in which the
hedged exposure impacts earnings. The effective portion of unrealized gains
(losses) recorded in accumulated other comprehensive income (loss), net of tax,
was a $0.3 million gain and a $1.4 million loss for the three months ended
July 1, 2007 and July 2, 2006, respectively, and a $0.8 million gain and a
$2.3 million loss for the six months ended July 1, 2007 and July 2, 2006,
respectively. As of July 1, 2007 and December 31, 2006, the Company
had outstanding cash flow hedge forward contracts with an aggregate notional
value of $60.2 million and $89.6 million, respectively. As of July 1, 2007
and December 31, 2006, the Company had outstanding cash flow hedge option
contracts with an aggregate notional value of $53.2 million and $16.0 million,
respectively. The maturity dates of the outstanding contracts ranged from July
2007 to April 2008.

Fair Value Hedges: On
occasion, the Company commits to purchase equipment in foreign currency,
predominantly Euros. When these purchases are hedged and qualify as firm
commitments under SFAS No. 133, they are designated as fair value hedges
and changes in the fair value of the firm commitment derivative contract are
recognized in the Condensed Consolidated Statement of Operations. Under fair
value hedge treatment, the changes in the firm commitment on a spot to spot
basis are recorded in property and equipment, net, in the Condensed
Consolidated Balance Sheet and in other income (expense), net in the Condensed
Consolidated Statement of Operations. As of July 1, 2007, the Company had no
outstanding fair value hedges.

Both cash flow hedges and
fair value hedges are tested for effectiveness each period on a spot to spot
basis using the dollar-offset method. Both the excluded time value and any
ineffectiveness, which were not significant for all periods, are recorded in
other income and (expense), net.

In addition, the Company
began hedging the net balance sheet effect of Euro denominated assets and
liabilities in 2005 primarily for Euro denominated receivables from customers,
prepayments to suppliers and advances received from customers. The Company
records its hedges of foreign currency denominated monetary assets and
liabilities at fair value with the related gains or losses recorded in other
income. The gains or losses on these contracts are substantially offset by
transaction gains or losses on the underlying balances being hedged. As of
July 1, 2007 and December 31, 2006, the Company held forward
contracts with an aggregate notional value of $29.8 million and $37.6 million,
respectively, to hedge the risks associated with Euro foreign currency
denominated assets and liabilities.

19

Note 10. Stock-Based
Compensation

The following table summarizes
the consolidated stock-based compensation expense, by type of awards:

Three Months Ended

Six Months Ended

(In thousands)

July 1, 2007

July 2, 2006

July 1, 2007

July 2, 2006

Employee stock options

$

4,847

$

1,018

$

9,593

$

2,172

Non-employee stock
options



19



304

Restricted stock

8,572

108

14,548

143

Amounts capitalized in inventory

(189

)

(8

)

(308

)

(70

)

Total stock-based compensation expense

$

13,230

$

1,137

$

23,833

$

2,549

The following table
summarizes the consolidated stock-based compensation expense by line item in
the Consolidated Statements of Operations:

Three Months Ended

Six Months Ended

(In thousands)

July 1, 2007

July 2, 2006

July 1, 2007

July 2, 2006

Cost of revenue

$

3,198

$

243

$

5,448

$

436

Research and
development

348

264

849

684

Sales, general and administrative

9,684

630

17,536

1,429

Total stock-based compensation expense

$

13,230

$

1,137

$

23,833

$

2,549

As stock-based compensation
expense recognized in the Condensed Consolidated Statements of Operations is
based on awards ultimately expected to vest, it has been reduced for estimated
forfeitures. SFAS No. 123(R) requires forfeitures to be estimated at the
time of grant and revised, if necessary, in subsequent periods if actual
forfeitures differ from those estimates.

Consolidated net cash
proceeds from the issuance of shares under the Companys employee stock plans
were $3.0 million and $5.0 million for the three and six months ended
July 1, 2007, respectively, and $1.4 million and $1.8 million for the
three and six months ended July 2, 2006, respectively. No income tax
benefit was realized from stock option exercises during the three and six
months ended July 1, 2007 and July 2, 2006. As required, the Company
presents excess tax benefits from the exercise of stock options, if any, as
financing cash flows rather than operating cash flows.

The following table
summarizes the unrecognized stock-based compensation costs by type of awards:

(In thousands, except years)

As of
July 1, 2007

Weighted-
Average
Amortization
Period
(in years)

Stock options

$

31,403

1.8

Restricted stock

29,941

3.4

Shares subject to re-vesting restrictions

31,949

1.5

Total unrecognized stock-based compensation balance

$

93,293

Equity Incentive Program

On May 4, 2007, the
Companys stockholders approved an additional increase in the number of shares
available for future issuance by 925,000 shares under the Companys Amended and
Restated 2005 Stock Incentive Plan under which the Company may issue
restrictive shares, stock appreciation rights, stock units, incentive or
non-statutory stock options to purchase common stock or stock purchase rights
to directors, employees and consultants.

The following table
summarizes the Companys stock option activities:

Shares
(in thousands)

Weighted-
Average
Exercise
Price Per Share

Options outstanding as of December 31, 2006

4,980

$

3.97

Options
exchanged/assumed in connection with SP Systems acquisition

1,602

5.54

Exercised

(720

)

2.78

Forfeited

(33

)

19.13

Options outstanding as of April 1, 2007

5,829

4.47

Granted

18

56.20

Exercised

(1,153

)

2.57

Forfeited

(35

)

10.64

Outstanding as of July 1, 2007

4,659

5.09

Exercisable as of July 1, 2007

1,345

3.69

20

Information regarding the
Companys outstanding stock options as of July 1, 2007 was as follows:

Options Outstanding

Options Exercisable

Range of Exercise Price

Shares
(in
thousands)

Weighted-
Average
Remaining
Contractual
Life
(in years)

Weighted-
Average
Exercise
Price per
Share

Aggregate
Intrinsic
Value
(in
thousands)

Shares
(in
thousands)

Weighted-
Average
Remaining
Contractual
Life
(in years)

Weighted-
Average
Exercise
Price per
Share

Aggregate
Intrinsic
Value
(in thousands)

$ 0.040.75

837

4.51

$

0.29

$

52,509

233

5.17

$

0.48

$

14,608

0.882.66

350

7.16

1.98

21,348

100

6.41

1.72

6,156

3.304.95

2,660

7.35

3.33

158,864

881

7.28

3.31

52,608

7.0016.20

421

8.15

8.34

23,071

91

8.14

8.24

4,974

17.0056.20

391

9.00

26.63

14,263

40

8.51

25.46

1,504

4,659

7.03

5.09

$

270,055

1,345

6.94

3.69

$

79,850

The aggregate intrinsic
value in the preceding table represents the total pre-tax intrinsic value,
based on the Companys closing stock price of $63.05 at July 1, 2007,
which would have been received by the option holders had all option holders
exercised their options as of that date. The total number of in-the-money
options exercisable was 1.3 million shares as of July 1, 2007.

The following table
summarizes the Companys non-vested stock options and restricted stock
activities:

Stock Options

Restricted Stock

Shares
(in thousands)

Weighted-
Average
Exercise Price
Per Share

Shares
(in thousands)

Weighted-
Average
Grant Date Fair
Value Per Share

Outstanding as
of December 31, 2006

3,141

$

4.45

229

$

35.40

Granted

1,602

5.54

269

41.68

Vested

(993

)

2.75

(16

)

33.34

Forfeited

(33

)

2.78

(4

)

39.86

Outstanding as
of April 1, 2007

3,717

5.39

478

38.97

Granted

18

56.20

337

57.19

Vested

(386

)

5.71

(31

)

56.58

Forfeited

(35

)

2.57

(15

)

57.13

Outstanding as of
July 1, 2007

3,314

5.66

769

45.62

Stock Unit Plan:

As of July 1, 2007, the
Company has granted approximately 192,431 units to approximately 1,734
employees in the Philippines at an average unit price of $32.75 in relation to
its 2005 Stock Unit Plan, under which participants are awarded the right to
receive cash payments from the Company in an amount equal to the appreciation
in the Companys common stock between the award date and the date the employee
redeems the award. A maximum of 300,000 stock units may be subject to stock
unit awards granted under the 2005 Stock Unit Plan. For the three and six
months ended July 1, 2007, total compensation expense associated with the 2005
Stock Unit Plan was $0.4 million and $0.8 million, respectively.

21

Note 11. Income Taxes

The Companys effective rate
of income tax benefit was 58% and 71% for the three and six months ended
July 1, 2007, respectively, and the effective rate of income tax provision
was 7% for each of the three and six months ended July 2, 2006. The tax
benefit for the first two quarters of fiscal 2007 was primarily attributable to
the recognition of deferred tax assets as a result of the Companys acquisition
of SP Systems and the effect of amortization of purchased intangible assets on
deferred tax liability, partially offset by non-U.S. taxes on income earned in
certain countries that was not offset by current year net operating losses in
other countries. The tax provision for the second quarter of fiscal 2006 was
attributable to non-U.S. taxes on income earned in certain countries that was
not offset by current year net operating losses in other countries.

Unrecognized Tax Benefits

The Company adopted the
provisions of FIN 48 on January 1, 2007. As of January 1, 2007, the
total amount of unrecognized tax benefits recorded in the Condensed
Consolidated Balance Sheet was approximately $1.1 million, which, if
recognized, would affect the Companys effective tax rate. The additional
amount of unrecognized tax benefits accrued during the first two quarters of
fiscal 2007 was $2.0 million. Management believes that events that could occur
in the next 12 months and cause a change in unrecognized tax benefits include,
but are not limited to, the following:

·completion of examinations of the Companys
tax returns by the U.S. or foreign taxing authorities; and

·expiration of statue of limitations on the
Companys tax returns.

The calculation of
unrecognized tax benefits involves dealing with uncertainties in the
application of complex global tax regulations. Uncertainties include, but are
not limited to, the impact of legislative, regulatory, and judicial
developments, transfer pricing and the application of withholding taxes.
Management regularly assesses the Companys tax positions in light of
legislative, bilateral tax treaty, regulatory and judicial developments in the
countries in which the Company does business. Management determined that an
estimate of the range of reasonably possible change in the amounts of
unrecognized tax benefits within the next 12 months cannot be made.

Classification of Interest and
Penalties

The Companys policy is to
classify interest expense and penalty, if any, as components of income tax
provision in the Condensed Consolidated Statements of Operations. No material
amount has been accrued through the first half of fiscal 2007.

Tax Years and Examination

The following table
summarizes the Companys major tax jurisdictions and the tax years that remain
subject to examination by these jurisdictions as of January 1, 2007:

Tax Jurisdictions

Tax Years

United States

2003 and onward

California

2002 and onward

Additionally, while years
prior to 2003 for the U.S. corporate tax return are not open for assessment,
the IRS can adjust net operating loss and research and development carryovers
that were generated in prior years and carried forward to 2003.

The Internal
Revenue Service (IRS) is currently conducting an audit of PowerLights
federal income tax returns for fiscal 2004. As of July 1, 2007, no material
adjustments have been proposed by the IRS.
Changes to PowerLights pre-acquisition tax liabilities, if any, would
be recorded as a purchase price adjustment.
Management believes that the ultimate outcome of the IRS examination
will not have a material impact on the Companys financial position or results
of operations.

Note 12. Segment and
Geographical Information

Prior to fiscal year 2007,
the Company operated in one business segment comprising the design, manufacture
and sale of solar electric power products, imaging and infrared detectors based
on its proprietary processes and technologies. Effective January 10, 2007,
the Company operated in two business segments: systems and components. The
systems segment generally represents sales directly to systems owners of
engineering, procurement, construction and other services relating to solar
electric power systems that integrate the Companys solar panels and balance of
systems components, as well as materials sourced from other manufactures. The
components segment primarily represents sales of the Companys solar cells,
solar panels and inverters to solar systems installers and other resellers. In
addition, the components segment includes sales of imaging and infrared
detectors to OEMs. The Chief Operating Decision Maker (CODM), as defined by
SFAS No. 131, Disclosures about Segments of an Enterprise and Related
Information (SFAS No. 131), assesses the performance of both operating
segments using information about its revenue and gross margin.

22

The following tables present
revenue by geography and segment, gross margin by segment, revenue by
significant customer and property, plant and equipment information based on
geographic region. Revenue is based on the destination of the shipments.
Property, plant and equipment are based on the physical location of the assets:

Three Months Ended

Six Months Ended

July 1, 2007

July 2, 2006

July 1, 2007

July 2, 2006

Revenue by geography:

United States

37

%

25

%

38

%

28

%

Germany

8

%

52

%

11

%

51

%

Spain

38

%



%

31

%



%

Austria

10

%



%

9

%



%

Rest of Europe

5

%

16

%

6

%

12

%

Asia

1

%

5

%

5

%

6

%

Others

1

%

2

%



%

3

%

100

%

100

%

100

%

100

%

Revenue by segment:

Systems

60

%



%

58

%



%

Components

40

%

100

%

42

%

100

%

100

%

100

%

100

%

100

%

Gross margin by segment:

Systems

12

%



%

16

%



%

Components

25

%

21

%

25

%

18

%

Significant
Customers:

Three Months Ended

Six Months Ended

Customer

Business Segment

July 1, 2007

July 2, 2006

July 1, 2007

July 2, 2006

SolarPack

Systems

34

%



%

20

%



%

Solon AG

Components

11

%

29

%

11

%

28

%

MMA Renewable Ventures

Systems

10

%



%

8

%



%

Conergy AG

Components

7

%

22

%

8

%

22

%

Elecnor

Systems

4

%



%

10

%



%

PowerLight Corporation

Components

n.a.

15

%

n.a.

14

%

(In thousands)

July 1, 2007

December 31, 2006

Property, plant and equipment
by geography:

United States

$

10,517

$

8,051

Philippines

285,259

192,335

China



2,042

$

295,776

$

202,428

Note 13. Commitments
and Contingencies

Operating Lease Commitments

The Company leases its San
Jose, California facility under a non-cancelable operating lease from Cypress,
which expires on April 30, 2011 (see Note 8). The lease also requires the
Company to pay property taxes, insurance and certain other costs. The Company
also leases its solar cell manufacturing facility in the Philippines from
Cypress, under a lease which expires in July 2021 (see Note 8). In December
2005, the Company entered into a 5-year operating lease from an unaffiliated
third party for an additional building in the Philippines. The Company also has
various lease arrangements for offices in Berkeley, California which expire
between 2007 and 2009, as well as for a field office in New Jersey, which
expires in 2011. In December 2006, the Company (through SP Systems acquired on
January 10, 2007) entered into an eleven-year lease agreement for its facility
in Richmond, California, which the Company expects to occupy in the fourth
quarter of 2007. Future minimum obligations under all non-cancelable operating
leases as of July 1, 2007 are as follows (in thousands):

2007 (remaining six months)

$

1,547

2008

4,095

2009

4,200

2010

4,248

2011

3,102

Thereafter

19,665

$

36,857

23

Purchase Commitments

The Company purchases raw
materials for inventory, services and manufacturing equipment from a variety of
vendors. During the normal course of business, in order to manage manufacturing
lead times and help assure adequate supply, the Company enters into agreements
with contract manufacturers and suppliers that either allow them to procure
goods and services based upon specifications defined by the Company, or that establish
parameters defining the Companys requirements. In certain instances, these
agreements allow the Company the option to cancel, reschedule or adjust the
Companys requirements based on its business needs prior to firm orders being
placed. Consequently, only a portion of the Companys recorded purchase
commitments arising from these agreements are firm, non-cancelable and
unconditional commitments.

The Company also has
agreements with several suppliers of polysilicon, ingots, wafers, solar cells
and solar panels and which specify future quantities and pricing of products to
be supplied by the vendors for periods up to 13 years and provide for certain
consequences, such as forfeiture of advanced deposits and liquidated damages
relating to previous purchases, in the event that the Company terminates the
arrangements (see Note 7).

At July 1, 2007, total
obligations related to such supplier agreements was $2.0 billion of which
$250.3 million was related to a joint venture (as discussed below). The Companys
non-cancelable purchase orders related to equipment and building improvements
totaled approximately $80.7 million.

Future minimum obligations
under supplier agreements and non-cancelable purchase orders as of July 1,
2007 and inclusive of minimum obligations under the supply agreement entered
into on July 16, 2007 (see Note 16) are as follows (in thousands):

2007 (remaining six months)

$

179,731

2008

264,944

2009

341,756

2010

272,739

2011

300,479

Thereafter

676,041

$

2,035,690

Joint Venture

In the third quarter of
fiscal 2006, the Company entered into an agreement with Woongjin Coway Co.,
Ltd. (Woongjin), a provider of environmental products located in Korea, to
form Woongjin Energy Co., Ltd (Woongjin Energy), a joint venture to
manufacture monocrystalline silicon ingots. Under the joint venture, the
Company and Woongjin will fund the joint venture through capital investments.
In addition, Woongjin Energy will obtain a $33.0 million loan to be guaranteed
by Woongjin. Additionally, the Company will supply polysilicon and technology
required for the silicon ingot manufacturing to the joint venture, and the
Company will procure the manufactured silicon ingots from the joint venture.
Woongjin Energy is expected to begin manufacturing in the fourth quarter of
fiscal 2007, and the Company expects to purchase approximately $250 million of
silicon ingots from Woongjin Energy under a five-year agreement.

The Company has invested
$4.8 million in the joint venture comprised of a 19.9% equity investment valued
at $1.5 million and a $3.3 million convertible note that is convertible at the
Companys option into an additional 20.1% equity ownership in the joint
venture. The entire investment is classified as Other Long-Term Assets in the
July 1, 2007 consolidated balance sheet. The Company accounted for its
joint venture in Woongjin Energy using the equity method, in which the minority
interest in the consolidated statements of operations is immaterial for the
three and six-month period ended July 1, 2007. Neither party has contractual
obligations to provide any additional funding to the joint venture. As of
July 1, 2007, the joint venture was in the development stage and had no
operations.

Product Warranties

The Company warrants or
guarantees the performance of its solar panels at certain levels of conversion
efficiency for extended periods, often as long as 25 years. It also warrants or
guarantees the functionality of solar cells and imaging detectors for at least
one year. Therefore, the Company maintains warranty reserves to cover potential
liability that could result from these guarantees. The Companys potential
liability is generally in the form of product replacement. Warranty reserves
are based on the Companys best estimate of such liabilities and are recognized
as a cost of revenue. The Company

24

continuously monitors product returns for warranty
failures and maintains a reserve for the related warranty expenses based on
historical experience of similar products as well as various other assumptions
that are considered reasonable under the circumstances. Warranty charges were
$1.4 million and $5.6 million during the three and six months ended July 1,
2007, respectively, and $1.3 million and $1.6 million during the three and six
months ended July 2, 2006, respectively.

The Company generally
provides warranty on systems for a period of five years. The Companys
estimated warranty cost for each project is accrued and the related costs are
charged against the warranty accrual when incurred. It is not possible to
predict the maximum potential amount of future warranty-related expenses under
these or similar contracts due to the conditional nature of the Companys
obligations and the unique facts and circumstances involved in each particular
contract. Historically, warranty costs related to contracts have been within
managements expectations.

The following summarizes
activity within accrued warranty:

Three Months Ended

Six Months Ended

(In thousands)

July 1, 2007

July 2, 2006

July 1, 2007

July 2, 2006

Balance at beginning of
the period

$

13,560

$

642

$

3,446

$

574

SP Systems
accrued balance at date of acquisition





6,542



Accruals for
warranties during the period

1,441

1,346

5,588

1,577

Settlements made
during the period

(687

)



(1,262

)

(163

)

Balance at the end of the period

$

14,314

$

1,988

$

14,314

$

1,988

Indemnifications

The Company is a party to a
variety of agreements pursuant to which it may be obligated to indemnify the
other party with respect to certain matters. Typically, these obligations arise
in connection with contracts and license agreements or the sale of assets,
under which the Company customarily agrees to hold the other party harmless
against losses arising from a breach of warranties, representations and
covenants related to such matters as title to assets sold, negligent acts,
damage to property, validity of certain intellectual property rights,
non-infringement of third-party rights, and certain tax related matters. In
each of these circumstances, payment by the Company is typically subject to the
other party making a claim to the Company pursuant to the procedures specified
in the particular contract. These procedures usually allow the Company to
challenge the other partys claims or, in case of breach of intellectual
property representations or covenants, to control the defense or settlement of
any third-party claims brought against the other party. Further, the Companys
obligations under these agreements may be limited in terms of activity
(typically to replace or correct the products or terminate the agreement with a
refund to the other party), duration and/or amounts. In some instances, the
Company may have recourse against third parties and/or insurance covering
certain payments made by the Company.

Note 14. Line of
Credit

On December 2, 2005, the
Company entered into a $25.0 million three-year revolving credit facility (the Facility)
with affiliates of Credit Suisse Securities (USA) LLC and Lehman Brothers, Inc.
The Facility was collateralized by substantially all of the Companys assets,
including the stock of its foreign subsidiaries. Borrowings under the Facility
were conditioned upon customary conditions as well as (1) with respect to
the first $10.0 million drawn on the Facility, maintenance of cash collateral
to the extent of outstanding borrowings (excluding amounts borrowed), and
(2) with respect to the remaining $15.0 million of the Facility,
satisfaction of a coverage test which was based on the ratio of the Companys
cash flow to capital expenditures. There were no borrowings ever made under the
Facility. The Company terminated its agreement with Credit Suisse Securities
(USA) LLC and Lehman Brothers, Inc., on July 13, 2007.

In connection with the SP
Systems acquisition on January 10, 2007, the Company assumed a line of credit
SP Systems had with Union Bank of California, N.A. (UBOC) with an outstanding
balance of approximately $3.6 million. During the first quarter of fiscal 2007,
the Company paid off the outstanding balance in full.

25

On
January 10, 2007, the Company amended and restated the loan agreement with
UBOC. The amended and restated loan agreement provided for a $10.0 million
trade finance credit facility, which was scheduled to expire on April 30,
2007. This facility allowed the Company to issue commercial and standby letters
of credit, but did not provide for any loans. All of the assets of SP Systems
secured this trade finance facility. In addition, the agreement required that
SP Systems maintain cash equal to the value of letter of credits outstanding in
restricted accounts as collateral for letters of credit issued by the bank. On
April 27, 2007, the Company through SP Systems entered into an amendment
to the loan agreement to, among other things, extend the maturity date to
July 31, 2007, and remove the requirement to have cash collateral for
letters of credit. The Company guaranteed $10.5 million in connection with
the April 27, 2007 amendment including the $10 million trade credit
facility and a separate $0.5 million credit card facility through UBOC.

On
July 13, 2007, the Company entered into a credit agreement with Wells Fargo
Bank, National Association (Wells Fargo) that replaced the credit lines with
Credit Suisse Securities (USA) LLC, Lehman Brothers, Inc., and UBOC (see Note
16).

Note
15. Senior Convertible Debentures and Share Loan Arrangement

February
2007 Debt Issuance

In February 2007, the
Company issued $200.0 million in principal amount of its 1.25% senior
convertible debentures (February 2007 Debentures). Interest on the February
2007 Debentures will be payable on February 15 and August 15 of each
year, commencing August 15, 2007. The February 2007 Debentures will mature
on February 15, 2027. Holders may require the Company to repurchase all or
a portion of their February 2007 Debentures on each of February 15,
2012, February 15, 2017 and February 15, 2022, or if the Company
experiences certain types of corporate transactions constituting a fundamental
change. Any repurchase of the Companys February 2007 Debentures pursuant to
these provisions will be for cash at a price equal to 100% of the principal
amount of the February 2007 Debentures to be repurchased plus accrued and
unpaid interest. In addition, the Company may redeem some or all of the
February 2007 Debentures on or after February 15, 2012 for cash at a
redemption price equal to 100% of the principal amount of the February 2007
Debentures to be redeemed plus accrued and unpaid interest.

Holders of the February 2007
Debentures may, under certain circumstances at their option, convert the
February 2007 Debentures into cash and, if applicable, shares of the Companys
class A common stock initially at a conversion rate of 17.6211 shares
(equivalent to an initial conversion price of approximately $56.75 per share),
at any time on or prior to maturity. The applicable conversion rate will be
subject to customary adjustments in certain circumstances.

The February 2007 Debentures
are senior, unsecured obligations of the Company, ranking equally with all
existing and future senior unsecured indebtedness of the Company. The February
2007 Debentures are effectively subordinated to the Companys secured
indebtedness to the extent of the value of the related collateral and
structurally subordinated to indebtedness and other liabilities of the Companys
subsidiaries. The February 2007 Debentures do not contain any covenants or
sinking fund requirements.

February
2007 Share Loan Arrangement

Concurrent with the offering
of February 2007 Debentures, the Company lent 2.9 million shares of its
class A common stock, all of which are being borrowed by an affiliate of Lehman
Brothers Inc. (LBIE), one of the underwriters of the February 2007 Debentures.
The Company did not receive any proceeds from that offering of class A
common stock, but received a nominal lending fee of $0.001 per share for each
share of common stock that is loaned pursuant to the share lending agreement
described below.

Share loans under the share
lending agreement will terminate and the borrowed shares must be returned to
the Company under the following circumstances: (i) LBIE may terminate all
or any portion of a loan at any time; (ii) the Company may terminate any
or all of the outstanding loans upon a default by LBIE under the share lending
agreement, including a breach by LBIE of any of its representations and
warranties, covenants or agreements under the share lending agreement, or the
bankruptcy of LBIE; or (iii) if the Company enters into a merger or
similar business combination transaction with an unaffiliated third party (as
defined in the agreement), all outstanding loans will terminate on the
effective date of such event.

Any shares loaned to LBIE
will be issued and outstanding for corporate law purposes and, accordingly, the
holders of the borrowed shares will have all of the rights of a holder of the
Companys outstanding shares, including the right to vote the shares on all
matters submitted to a vote of the Companys stockholders and the right to
receive any dividends or other distributions that the Company may pay or make
on its outstanding shares of class A common stock.

While the share lending
agreement does not require cash payment upon return of the shares, physical
settlement is required (i.e., the loaned shares must be returned at the end of
the arrangement). In view of this and the contractual undertakings of LBIE in
the share lending agreement, which have the effect of substantially eliminating
the economic dilution that otherwise would result from the issuance of the
borrowed shares, the Company believes that under generally accepted accounting
principles of the United States, the borrowed shares will not be considered
outstanding for the purpose of computing and reporting earnings per share.
Notwithstanding the foregoing, the shares will nonetheless be issued and
outstanding and will be eligible for trading on The Nasdaq Global Market.

26

Note 16. Subsequent Events

Credit Agreement with Wells Fargo Bank, National Association

On July 13, 2007, the
Company entered into a credit agreement with Wells Fargo providing for a $50.0
million unsecured revolving credit line and a $15.0 million secured letter of
credit facility. During the first year of the three-year term of the agreement,
the Company may borrow up to $50.0 million, and during the full three-year
term, the Company may request that Wells Fargo issue up to $15.0 million in
letters of credit. As detailed in the agreement, the Company will pay interest
on outstanding borrowings and a fee for outstanding letters of credit. The
Company has the ability at any time to prepay outstanding loans. All borrowings
must be repaid by July 31, 2008, and all letters of credit shall expire no
later than July 31, 2010. The Company concurrently entered into a security
agreement with Wells Fargo, granting a security interest in a deposit account
to secure its obligations in connection with any letters of credit that might
be issued under the credit agreement. In connection with the credit agreement,
SunPower North America, Inc., a wholly-owned subsidiary of the Company, and SP
Systems, another wholly-owned subsidiary the Company, entered into an
associated continuing guaranty with Wells Fargo. The terms of the credit
agreement include certain conditions to borrowings, representations and
covenants, and events of default customary for financing transactions of this
type.

In connection with the Wells
Fargo credit agreement, three letters of credits issued by UBOC have been
replaced by letters of credit issued by Wells Fargo. The Company also issued a letter of credit
for $7.5 million, expiring on August 8, 2007, through Wells Fargo to UBOC as a
requirement by UBOC for the early release of UBOCs security interest in SP
Systems assets (see Note 14). In connection with the Wells Fargo credit
agreement, the Company terminated its previous credit facility with affiliates
of Credit Suisse Securities (USA) LLC and Lehman Brothers, Inc. Our line of
credit with UBOC expired on July 31, 2007.

Polysilicon Supply Agreement with Hemlock Semiconductor Corporation

On July 16, 2007, the
Company entered into a polysilicon supply agreement with Hemlock Semiconductor
Corporation (Hemlock). The agreement provides the general terms and
conditions pursuant to which the Company will purchase, on a firm commitment
basis, fixed annual quantities of polysilicon at specified prices from 2010
through 2019. Under the agreement, the Company is required to make prepayments
to Hemlock prior to 2010 in the aggregate amount of $113.2 million in three
equal installments. Such prepayments will be used to fund the expansion of
Hemlocks polysilicon manufacturing capacity and will be credited against
future deliveries of polysilicon to the Company. The required prepayments,
together with the balance of the Companys firm commitment payment obligations
under the agreement, represent a material financial obligation of the Company.

July 2007 Equity and Debt Issuances

In July 2007, the Company
issued and sold, in a public offering, 2.7 million shares of class A common
stock at a price of $64.50 per share, and issued and sold $225.0 million
aggregate principal amount of 0.75% senior convertible debentures due in 2027
(the July 2007 Debentures).

The July 2007 Debentures
bear interest at a rate of 0.75% per year, payable on February 1 and August 1
of each year, commencing on February 1, 2008. The July 2007 Debentures will
mature on August 1, 2027. Holders may require the Company to repurchase all or
a portion of their July 2007 Debentures on each of August 1, 2010, August 1,
2015, August 1, 2020, and August 1, 2025, or if the Company is involved in
certain types of corporate transactions constituting a fundamental change. Any
repurchase of the July 2007 Debentures pursuant to these provisions will be for
cash at a price equal to 100% of the principal amount of the July 2007
Debentures to be repurchased plus accrued and unpaid interest. In addition, the
Company may redeem some or all of the July 2007 Debentures on or after August
1, 2010 for cash at a redemption price equal to 100% of the principal amount of
the July 2007 Debentures to be redeemed plus accrued and unpaid interest.

Holders of the July 2007
Debentures may, under certain circumstances at their option, convert the
principal amount of their debentures into cash and, with respect to any amounts
in excess of the principal amount, at the Companys option, additional cash or
shares of the Companys class A common stock initially at a conversion rate of
12.1599 shares (equivalent to an initial conversion price of approximately
$82.24 per share) per $1,000 principal amount of July 2007 Debentures, at any
time on or prior to maturity. The applicable conversion rate will be subject to
customary adjustments in certain circumstances.

The July 2007 Debentures are
senior, unsecured obligations of the Company, ranking equally with all existing
and future senior unsecured indebtedness of the Company. The July 2007
Debentures are effectively subordinated to the Companys secured indebtedness
to the extent of the value of the related collateral, and structurally subordinated
to indebtedness and other liabilities of the Companys subsidiaries.

Amendment and Restatement of Share Lending
Agreement with LBIE

In connection
with the issuance of the February 2007 Debentures, the Company lent 2.9 million
shares of its class A common stock to LBIE, one of the underwriters of the
February 2007 Debentures, to be used to facilitate the establishment by
investors in the February 2007 Debentures of hedged positions in the Companys
class A common stock. Under the share lending agreement the Company entered
into with LBIE, LBIE was entitled to offer up to 1.0 million of those shares on
a delayed basis only to facilitate hedging arrangements for subsequent
purchasers of the February 2007 Debentures. In connection with the issuance of
the July 2007 Debentures, we amended and restated the share lending agreement
with LBIE to enable LBIE to offer any of the 1.0 million shares that remain in
LBIE's possession to facilitate hedging arrangements for subsequent purchasers
not only of the February 2007 Debentures, but also subsequent purchasers of the
July 2007 Debentures and, with the Companys consent, purchasers of securities
the Company may issue in the future. In addition, LBIE has agreed to return to
us any borrowed shares in its possession on the date anticipated to be five
business days before the closing of a merger or similar business combination
transaction intended to qualify as a reorganization under section 368 of the
Internal Revenue Code to which we or an affiliate of the Company is a party and
upon consummation of which it is reasonably expected that at least 80% of our
capital stock (or that of the surviving corporation if the Company is acquired)
will be held by non-affiliates of the Company or of such surviving corporation.

27

July 2007 Share Loan Arrangement

Concurrent with the offering
of July 2007 Debentures, the Company lent 1.8 million shares of its class
A common stock, all of which are being borrowed by an affiliate of Credit
Suisse Securities (USA) LLC (CSI), one of the underwriters of the July 2007 Debentures.
The Company did not receive any proceeds from that offering of class A
common stock, but received a nominal lending fee of $0.001 per share for each
share of common stock that is loaned pursuant to the share lending agreement
described below.

Share loans under the share
lending agreement will terminate and the borrowed shares must be returned to
the Company under the following circumstances: (i) CSI may terminate all
or any portion of a loan at any time; (ii) the Company may terminate any
or all of the outstanding loans upon a default by CSI under the share lending
agreement, including a breach by CSI of any of its representations and
warranties, covenants or agreements under the share lending agreement, or the bankruptcy
of CSI; or (iii) if the Company enters into a merger or similar business
combination transaction with an unaffiliated third party (as defined in the
agreement), all outstanding loans will terminate on the effective date of such
event. In addition, CSI has agreed to return to the Company any borrowed shares
in its possession on the date anticipated to be five business days before the
closing of certain merger or similar business combinations described in the
share lending agreement. Except in limited
circumstances, any such shares returned to the Company cannot be reborrowed.

Any shares loaned to CSI
will be issued and outstanding for corporate law purposes and, accordingly, the
holders of the borrowed shares will have all of the rights of a holder of the
Companys outstanding shares, including the right to vote the shares on all
matters submitted to a vote of the Companys stockholders and the right to
receive any dividends or other distributions that the Company may pay or make
on its outstanding shares of class A common stock.

While the share lending
agreement does not require cash payment upon return of the shares, physical
settlement is required (i.e., the loaned shares must be returned at the end of
the arrangement). In view of this and the contractual undertakings of CSI in
the share lending agreement, which have the effect of substantially eliminating
the economic dilution that otherwise would result from the issuance of the
borrowed shares, the Company believes that under generally accepted accounting
principles of the United States, the borrowed shares will not be considered
outstanding for the purpose of computing and reporting earnings per share.
Notwithstanding the foregoing, the shares will nonetheless be issued and
outstanding and will be eligible for trading on The Nasdaq Global Market.

28

Item 2.Managements Discussion and
Analysis of Financial Condition and Results of Operations

Cautionary Statement Regarding Forward-Looking Statements

This
Quarterly Report on Form 10-Q of SunPower Corporation and its subsidiaries (SunPower
or the Company, Us, We or Our) contains forward-looking statements.
This Quarterly Report on Form 10-Q also includes data, including
forward-looking information, pertaining to PowerLight Corporation, our wholly-owned
subsidiary, which we acquired on January 10, 2007, and subsequently named
SunPower Corporation, Systems (SP Systems). All statements in this Quarterly
Report on Form 10-Q, including those made by the management of SunPower, other
than statements of historical fact, are forward-looking statements. These
forward-looking statements are made pursuant to safe harbor provisions of the
Private Securities Litigation Reform Act of 1995. Examples of forward-looking
statements include statements regarding our ability to obtain polysilicon
ingots or wafers, future financial results, operating results, business
strategies, projected costs, products, competitive positions, managements
plans and objectives for future operations, and industry trends. These forward-looking
statements are based on managements estimates, projections and assumptions as
of the date hereof and include the assumptions that underlie such statements.
Forward-looking statements may contain words such as may, will, should, could,
would, expect, plan, anticipate, believe, estimate, predict, potential,
and continue, the negative of these terms, or other comparable terminology.
Any expectations based on these forward-looking statements are subject to risks
and uncertainties and other important factors, including those discussed below
and in the section titled PART II  OTHER INFORMATION, ITEM 1A. RISK
FACTORS. Other risks and uncertainties are disclosed in our prior filings with
the Securities and Exchange Commission (SEC), including our 2006 Annual
Report on Form 10-K, Quarterly Report on Form 10-Q for the period ended April
1, 2007, and Current Reports on Form 8-K. These and many other factors could
affect our future financial condition and operating results and could cause
actual results to differ materially from expectations based on forward-looking
statements made in this document or elsewhere by us or on our behalf. We
undertake no obligation to revise or update any forward-looking statements.

The
following information should be read in conjunction with the Consolidated
Financial Statements and the accompanying Notes to Consolidated Financial
Statements included in this Quarterly Report on Form 10-Q. Our fiscal quarters
end on the Sunday closest to the end of the applicable calendar quarter. All
references to fiscal periods apply to our fiscal quarters or year which ends on
the Sunday closest to the calendar month end.

Overview

We design, manufacture and
market high-performance solar electric power technology. Our solar cells and
solar panels are manufactured using proprietary processes and technologies
based on more than 15 years of research and development. We believe our
solar cells have the highest conversion efficiency, a measurement of the amount
of sunlight converted by the solar cell into electricity, of all the solar
cells available for the mass market. Our solar power products are sold through
our components business segment, or our components segment. In
January 2007, we acquired PowerLight, which developed, engineered,
manufactured and delivered large-scale solar power systems. These activities
are now performed by our systems business segment, or our systems segment. Our
solar power systems, which generate electric energy, integrate solar cells and
panels manufactured by us as well as other suppliers.

·efficient
use of silicon, a key raw material used in the manufacture of solar cells.

We sell our solar components
products to installers and resellers for use in residential and commercial
applications where the high efficiency and superior aesthetics of our solar
power products provide compelling customer benefits. We also sell products for
use in multi-megawatt solar power plant applications. In many situations, we
offer a materially lower area-related cost structure for our customers because
our solar panels require a substantially smaller land area than conventional
solar technology and half or less of the land area of commercial solar thin
film technologies. We sell our products in countries in Europe, Asia and North
America, principally in regions where government incentives have accelerated
solar power adoption.

29

We manufacture our solar
cells at our manufacturing facilities in the Philippines. We currently operate
four cell manufacturing lines in our first solar cell manufacturing facility,
with a total rated manufacturing capacity of approximately 108 megawatts per
year. In addition, we recently began operating the first line in a second solar
cell manufacturing facility in the Philippines, which is designed to house up
to ten manufacturing lines. We expect three manufacturing lines in this new
facility to be operational by the end of 2007, resulting in a total of seven
manufacturing lines with an aggregate production capacity of 207 megawatts per
year. By the end of 2008, we plan to operate 12 solar cell manufacturing lines
with an aggregate manufacturing capacity of 372 megawatts per year. We have
recently announced plans to begin production in late 2009 on the first line of
a third solar cell manufacturing facility designed to have an aggregate
manufacturing capacity of 500 megawatts per year.

We manufacture our solar
panels at our automated panel manufacturing factory located in the Philippines.
Our solar panels are also manufactured for us by a third-party subcontractor in
China. We currently operate one solar panel manufacturing line with a rated
manufacturing capacity of 30 megawatts of solar panels per year. We plan to
begin operating a second solar panel manufacturing facility by the end of 2007
that is designed to house up to ten manufacturing lines. We have ordered
equipment for three new solar panel manufacturing lines that we expect to begin
operating in the fourth quarter of 2007 and the first quarter of 2008. We
expect to move our currently operating manufacturing line to this facility in
the future.

Our SunPower branded
inverters are manufactured for us by multiple suppliers.

Systems segment: We sell solar power systems, which may
include services such as development, engineering, procurement of permits and
equipment, construction management, access to financing, monitoring and
maintenance, directly to system owners. Our systems segment is comprised
primarily of the business we acquired from SP Systems in January 2007. Our
customers include commercial and governmental entities, investors, utilities
and production home builders. We work with construction, system integration and
financing companies to deliver our solar power systems to customers. Our solar
power systems generate electricity over a system design life typically
exceeding 25 years and are principally designed to be used in large-scale
applications with system ratings of more than 300 kilowatts. Worldwide, we have
completed or are in the process of completing over 350 projects, rated in
aggregate at over 200 megawatts peak capacity.

We have solar power system
projects completed or in the process of being completed in various countries
including Germany, Portugal, South Korea, Spain and the United States. In the
United States, we sell distributed rooftop and ground-mounted solar power
systems as well as central-station power plants. Distributed solar power
systems are typically rated up to one megawatt of capacity to provide a
supplemental, distributed source of electricity for a customers facility. Many
customers choose to purchase solar electricity from our systems under a power
purchase agreement with a financing company which buys the system from us. We
are currently constructing an approximately 15 megawatt solar power plant at
Nellis Air Force Base in Nevada, which will be operated under a power purchase
agreement structure. In Europe and South Korea, our products and systems are
typically purchased by a financing company and operated as a central station
solar power plant. These power plants are rated with capacities of
approximately one to 20 megawatts, and generate electricity for sale under
tariff to regional and public utilities.

We manufacture certain of
our solar power system products at our manufacturing facilities in California
and at other facilities located close to our customers. Some of our solar power
system products are also manufactured for us by third party suppliers.

Acquisition of PowerLight Corporation

On January 10, 2007, we
completed our merger transaction involving PowerLight. Upon the completion of
the merger, all of the outstanding shares of PowerLight, and a portion of each
vested option to purchase shares of PowerLight, were cancelled, and all of the
outstanding options to purchase shares of PowerLight (other than the portion of
each vested option that was cancelled) were assumed by us in exchange for
aggregate consideration of (i) approximately $120.7 million in cash plus
(ii) a total of 5,708,723 shares of class A common stock, inclusive
of (a) 1,145,643 shares of class A common stock which may be issued
upon the exercise of assumed vested and unvested PowerLight stock options and
(b) 1,675,881 shares of class A common stock issued to employees of
PowerLight in connection with the merger which, along with 530,238 of the
shares issuable upon exercise of assumed PowerLight stock options, are subject
to certain transfer restrictions and a repurchase option held by us, both of
which lapse over a two-year period under the terms of equity restriction
agreements. Under the terms of the merger agreement, we also issued an
additional 204,623 shares of restricted class A common stock to certain
employees of PowerLight, which shares are subject to certain transfer
restrictions which will lapse over 4 years. In June 2007, the Company changed
PowerLights name to SunPower Corporation, Systems, or SP Systems, to
capitalize on SunPowers name recognition.

30

The total consideration
related to the acquisition was as follows:

(In thousands)

Shares

Fair Value at
January 10, 2007

Purchase
consideration:

Cash



$

120,694

Common stock

2,961

111,266

Stock options assumed that are fully vested

618

21,280

Direct transaction costs



2,958

Total purchase consideration

3,579

256,198

Future stock
compensation:

Restricted stock

1,146

$

43,046

Stock options assumed but that are unvested

984

35,126

Total future stock compensation

2,130

78,172

Total purchase
consideration and future stock compensation

5,709

$

334,370

Purchase Price Allocation

Under
the purchase method of accounting, the total purchase price as shown in the
table above was allocated to SP Systems net tangible and intangible assets
based on their estimated fair values as of the date of acquisition. The
purchase price has been allocated based on managements best estimates. The
fair value of our class A common stock issued was determined based on the
average closing prices for a range of trading days around the announcement date
(November 15, 2006) of the transaction. The fair value of stock options assumed
was estimated using the Black-Scholes model with the following assumptions:
volatility of 90%, expected life ranging from 2.7 years to 6.3 years, and
risk-free interest rate of 4.6%.

The
allocation of the purchase price and the estimated useful lives associated with
the acquired assets and liabilities on January 10, 2007 was as follows:

(In thousands)

Amount

Estimated
Useful Life

Net tangible assets

$

13,925

n.a.

Patents and purchased technology

29,448

4 years

Tradenames

15,535

5 years

Backlog

11,787

1 year

Customer relationships

22,730

6 years

In-process research and development

9,575

n.a.

Unearned stock compensation

78,172

n.a.

Deferred tax liability

(21,964

)

n.a.

Goodwill

175,162

n.a.

Total purchase
consideration and future stock compensation

$

334,370

In June 2007, we changed our
branding strategy and consolidated all of our product and service offerings under
the SunPower tradename. To reinforce the new branding strategy, we
formally changed the name of PowerLight to SunPower Corporation, Systems, or SP
Systems. The fair value of PowerLight tradenames was valued at $15.5
million at the date of acquisition and ascribed a useful life of 5 years. The
determination of the fair value and useful life of the tradename was based on
our previous strategy of continuing to market our systems products and services
under the PowerLight brand. Based on the change in our branding strategy,
during the three-month period ended July 1, 2007 we recognized an impairment
charge of $14.1 million which represented the net book value of the PowerLight
tradename.

31

Relationship
with Cypress Semiconductor Corporation

Cypress made a significant
investment in SunPower in 2002. On November 9, 2004, Cypress completed a
reverse triangular merger with us in which all of the outstanding minority
equity interest of SunPower was retired, effectively giving Cypress 100%
ownership of all of our then outstanding shares of capital stock but leaving
our unexercised warrants and options outstanding. After completion of our
initial public offering in November 2005, Cypress held, in the aggregate,
52,033,287 shares of class B common stock.

On May 4, 2007, Cypress
completed the sale of 7,500,000 shares of class B common stock in an offering
pursuant to Rule 144 of the Securities Act. Such shares converted to 7,500,000
shares of class A common stock upon the sale. As of July 1, 2007,
including the effect of the sale completed in May 2007 and the secondary public
offering in June 2006, Cypress owned 44,533,287 shares of class B common stock,
which represented approximately 59% of the total outstanding shares of the our
common stock, or approximately 55% of such shares on a fully diluted basis
after taking into account outstanding stock options (or 53% of such shares on a
fully diluted basis after taking into account outstanding stock options and
loaned shares to underwriters of our convertible indebtedness), and 91% of the
voting power of our total outstanding common stock. After the public offerings
of class A common stock and senior convertible debentures on July 31, 2007,
Cypress held approximately 57% of the total outstanding shares of our common
stock, or approximately 53% of such shares on a fully diluted basis after
taking into account outstanding stock options (or 50% of such shares on a fully
diluted basis after taking into account outstanding stock options and loaned
shares to underwriters of our convertible indebtedness) and 90% of the voting
power of our total outstanding common stock.

Cypress, its successors in
interest or its subsidiaries may convert their shares of class B common
stock into shares of class A common stock on a one-for-one basis at any
time. Cypress announced on October 6, 2006 and reiterated on
October 19, 2006 that it was exploring ways in which to allow its
stockholders to fully realize the value of its investment in SunPower. Cypress
has made public statements since October 19, 2006 that were consistent
with these announcements.

Critical
Accounting Policies

Our
critical accounting policies are disclosed in our Form 10-K for the year ended
December 31, 2006 and have not changed materially as of July 1, 2007,
with the exception of the following:

Revenue and Cost Recognition for Construction Contracts

We
recognize revenues from fixed price contracts under AICPA Statement of Position
(SOP) 81-1, Accounting for Performance of Construction-Type and Certain
Production-Type Contracts, using the percentage-of-completion method of
accounting. Under this method, revenue is recognized as work is performed based
on the percentage that incurred costs bear to estimated total forecasted costs
utilizing the most recent estimates of forecasted costs.

Incurred costs include all
direct material, labor, subcontract costs, and those indirect costs related to
contract performance, such as indirect labor, supplies, tools and repairs. Job
material costs are included in incurred costs when the job materials have been
installed. Where contracts stipulate that title to job materials transfers to
the customer before installation has been performed, revenue is deferred and
recognized upon installation, in accordance with the percentage-of-completion
method of accounting. Job materials are considered installed materials when
they are permanently attached or fitted to the solar power system as required
by the jobs engineering design.

Due to inherent
uncertainties in estimating cost, job costs estimates are reviewed and/or
updated by management working within the systems segment. The systems segment
determines the completed percentage of installed job materials at the end of
each month; generally this information is also reviewed with the customers
on-site representative. The completed percentage of installed job materials is
then used for each job to calculate the month-end job material costs incurred.
Direct labor, subcontractor, and other costs are charged to contract costs as
incurred. Provisions for estimated losses on uncompleted contracts, if any, are
recognized in the period in which the loss first becomes probable and
reasonably estimable. Contracts may include profit incentives such as milestone
bonuses. These profit incentives are included in the contract value when their
realization is reasonably assured.

As of July 1, 2007, the
asset, Costs and estimated earnings in excess of billings, which represents
revenues recognized in excess of amounts billed, was $23.5 million. The
liability, Billings in excess of costs and estimated earnings, which
represents billings in excess of revenues recognized, was $48.6 million.

32

Cash in Restricted Accounts

Cash in restricted accounts
represents collateral for letters of credit issued by a commercial bank in
favor of our suppliers and customers. Generally, the funds will be released
upon payment to the suppliers and the successful completion of the customer
contracts. As of July 1, 2007, we did not have cash in restricted accounts.

Deferred Project Costs

Deferred project costs
represent uninstalled materials on contracts for which title had transferred to
the customer and are recognized as deferred assets until installation. As of
July 1, 2007, deferred project costs totaled $24.9 million.

Foreign Currency Translation

Assets and liabilities of SP
Systems wholly-owned foreign subsidiaries are translated from their respective
functional currencies at exchange rates in effect at the balance sheet date,
and revenues and expenses are translated at average exchange rates prevailing
during the applicable period. The resulting translation adjustment as of
July 1, 2007 was $1.9 million and is reflected as a component of
accumulated other comprehensive income (loss) in stockholders equity.

Purchase Accounting

We record all assets and
liabilities acquired in purchase acquisitions, including goodwill, identified
intangible assets and in-process research and development, at fair value as
required by SFAS No. 141, Business Combinations. The initial recording
of goodwill, identified intangible assets and in-process research and
development requires certain estimates and assumptions especially concerning
the determination of the fair values and useful lives of the acquired
intangible assets. The judgments made in the context of the purchase price
allocation can materially impact our future results of operations. Accordingly,
for significant acquisitions, we obtain assistance from third party valuation
specialists. The valuations are based on information available at the
acquisition date. Goodwill is not amortized but is subject to annual tests for
impairment or more often if events or circumstances indicate they may be
impaired. Other identified intangible assets are amortized over their estimated
useful lives and are subject to impairment if events or circumstances indicate
a possible inability to realize the carrying amount.

In-Process Research and Development Charge, or IPR&D Charge

In connection with the
acquisition of SP Systems, we recorded an IPR&D charge of $9.6 million in
the first quarter of fiscal 2007, as technological feasibility associated with
the in-process research and development projects had not been established and
no alternative future use existed.

We identified in-process
research and development projects in areas for which technological feasibility
had not been established and no alternative future use existed. These
in-process research and development projects consist of two components: design
automation tool and tracking systems and other. In assessing the projects, we
considered key characteristics of the technology as well as its future
prospects, the rate technology changes in the industry, product life cycles,
and various projects stage of development.

The value of in-process
research and development was determined using the income approach method, which
calculated the sum of the discounted future cash flows attributable to the
projects once commercially viable using a 40% discount rate, which were derived
from a weighted-average cost of capital analysis and adjusted to reflect the
stage of completion of the projects and the level of risks associated with the
projects. The percentage of completion for each project was determined by
identifying the research and development expenses invested in the project as a
ratio of the total estimated development costs required to bring the project to
technical and commercial feasibility. The following table summarizes certain
information of each significant project: